Having a budget is one of the most effective strategies you can put in place to build your wealth. Contrary to what you may think, creating a budget will allow you even more freedom because once something has been budgeted for you can spend that money without feeling guilty. Many people even say they find "extra" money after they create a realistic budget and stick with it. How amazing is that?
I recommend building a zero-based budget. It’s easy to set up, simple to follow and in my opinion, the most effective way to keep track of where your money is going.
So what exactly is a zero-based budget?
In a zero-based budget, you total your inflows and then subtract all your outflows so that they equal zero. In this form of budgeting every dollar has a function and must be accounted for.
Let me give you an example. If you earn $5,000 a month, everything you spend, save, give or invest in a month must add up to $5,000. By doing this you’ll know exactly where every dollar is going and you will create intention behind your spending. Below are my five steps to create a zero-based budget:
- Determine your monthly income. If you’re on salary and are paid twice a month, simply double the amount coming in every pay. However, if you’re paid every two weeks you’ll need to multiply your bi-weekly pay by 26 and then divide by 12 to see what your net monthly income is. Don’t forget to add in any other small-business income – a side hustle, rental income, child support, and any other cash you bring in. That’s your starting point.
- Track your fixed monthly expenses. To make things easier, here is a budget spreadsheet you can use. Write down all of your expenses and put them in categories. Everything should be included. Start with your living essentials. That’s food, shelter and utilities, personal essentials, and transportation. After you’ve got all those covered, continue listing the rest of your fixed monthly expenses. Make sure that you include an expense category devoted to savings. This is your commitment to paying yourself first and to your future. Consider this: $100 a week at 6% would grow to over $200,000 in 20 years. Of course, if you have debt, especially bad debt like high interest credit cards, you’ll need to take care of this before anything else and decide how much you’re going to pay off each month.
- Write down your seasonal or irregular expenses. Do this by thinking through the whole calendar year. What expenses will you need to plan for? Things like birthdays, anniversaries and holidays are set dates that shouldn’t surprise you—or your budget. There’s no reason to act like Christmas suddenly snuck up on you. Next, think about all the irregular expenses that pop up. License plate renewal fees, property taxes, and even your annual insurance premiums should be budgeted for. For example, if you pay a $1,200 annual premium on life insurance, set aside $100 a month and that way you won’t feel the strain of an expense "blindsiding" you. The other ‘silent’ expense you should include as a line item in your budget is an emergency fund. It’s always the unexpected things – like car repairs, or a broken-down appliance that throw us a big curve ball. So expect the unexpected. By ensuring you have some funds set aside, when those unexpected things crop up you won’t have to scramble to figure out where the money will come from. I also encourage you to look a little further into the future. Are you planning a major purchase or perhaps an expensive trip next year? Divide the total cost by the number of months until the purchase date. Add that amount to your monthly budget so the total is there when it’s time to pay for it. Just because an expense doesn’t hit you right away doesn’t mean it isn’t real, so when creating a budget, you’ll need to spend some time thinking about your future plans and purchases. Once you include all these expenses alongside your regular monthly expenses, your budget will better reflect the reality of your present and future needs.
- Subtract your monthly expenses from your income so that they equal zero. This is where you will likely need to make some adjustments. If it turns out you’re spending more than you make, you’ll need to adjust and prioritize. Basic living expenses should be at the top and fully covered. If, on the other hand you fill out every line item in your budget and come out $100 ahead, congratulations! But you still haven’t finished your budget because you need to put that extra $100 somewhere. Where? That’s up to you. You can spend it, increase your savings, invest it, or donate it. Regardless of what you decide, to be in full control, you must account for it so that your budget equals zero.
- Track your expenses throughout the month. This final step is how you will know if your spending lines up with your plan! When you track your expenses and are intentional with your money, you will start to see progress towards your goal and feel comfortable with your spending, savings and debt reduction.
For more information on how to put your zero-based budget into action, listen to my podcast on the topic.
Mark Shimkovitz is a financial advisor with Raymond James Ltd. The views of the author do not necessarily reflect those of Raymond James. This article is for information only. Raymond James Ltd. member of Canadian Investor Protection Fund.