How to Create a Zero-Based BudgetOctober 24, 2016
Updated March 2, 2020
It is a well-known fact that a budget is a useful tool to take control of your finances, pay off debt, and save for the future. If you have started a budget and it is working for you, chances are you have money left over by the end of the month to spend freely. You have successfully stuck to your budget, so why not treat yourself with the remainder? You spend what is left and start over next month. However, after a while, you may be scratching your head wondering where all that extra money went. That is where zero-based budgeting comes in.
What if you were told to “spend” all of your income each month? This might sound crazy at first, but many financial experts regard this method as the most effective one out there. The concept of zero-based budgeting is that your monthly income minus your expenses should equal zero. The idea is that each dime you make should have a “job” and fall into a certain category in your budget. For example, if your take-home pay is $5,000, you have exactly $5,000 to spend, save, or invest. Here is how you can create your own zero-based budgeting system:
Track Your Expenses
In most cases, you will need to track your expenses for a month or two to see what you typically spend in each category. Figuring out what percentage of your income goes to which expense can help you when writing your budget. If you already have a budget that works, you can move on to the second step.
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Create Categories of Expenses
Based on your monthly expenses, make a list of the major categories you spend money in. First, think about your fixed expenses — mortgage, utilities, phone bill, student loan payments, car payments, credit card bills — and create a category of recurring expenses. Then, analyze your bank statements to determine other categories such as transportation/gas, groceries, entertainment, and personal care (clothing, haircuts, etc.). Be fairly generous to yourself in these categories — you want to allocate enough to them so you will not be tempted to use your leftovers. Once you have done this, the next step is assigning an amount of money to each category based on previous months.
Assign the Leftovers to Categories
Subtract the amount you have allotted for each of these categories from your monthly income to see what is left over. In a regular budgeting system, you might save a percentage of your money and spend what is left over. However, in zero-based budgeting, each dollar must be accounted for. You will want to save or invest the remaining balance. Assign each dollar to one of those categories until you are left with zero.
Maximize Your Wealth-Building Potential
When every penny you earn serves a purpose — whether going toward paying your monthly expenses, investing, or straight to your savings account — you know exactly where your money is going, and you will never have to wonder where that extra $250 went. With the zero-based system, that $250 is probably in savings, and you are well on your way to financial freedom.
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