Zero-Based Budget

It’s easy to say that we want to change or improve, but taking real action is much harder. In this post, I will discuss the Zero-Based Budget approach.

What you will read next is an example of how I changed and, consequently, improved my budgeting process.

It’s been a while since I started tracking my financials. By financials, I mean usual personal finance indicators such as expenses, savings rate, liabilities, net worth, etc.

“To help me keep track of my money, I budget every single month!”

My strategy for budgeting was the classic approach until this year. It mainly consisted of splitting my income into needs, wants, and savings with fixed allocations.

A usual split is the 50/30/20 budget. This works by allocating:

  • 50% of the Income to essential living (housing, utilities, groceries)
  • 30% to wants (entertainment, dining out, vacations)
  • 20% to savings/investments

My Own Budget Split

I did feel this was allocating too much money every month, to both essential living costs and wants. So I decided to implement a 40/20/40 budget instead.

40% essentials, 20% wants, and 40% to savings.

Generally, my essential living costs fall under 40% of my income, so it is possible to be more aggressive with my savings.

While I had moderate success with this approach in 2019 and saved roughly 39K€, I did fail my yearly savings goal of 40K€.

Indeed, I did not miss by much, but it’s still a miss!

If we think as a football player, a miss is always a miss and we only count when we score a goal…

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Improving My Budget

In 2020, I wanted to hit my goal no matter what. After some reading about the Zero-Based Budget (ZBB) strategy, I started using it myself.

In a nutshell, a Zero-Based Budget approach assumes that all our Income will be allocated to a specific bucket, and there will be nothing left at the end of each month.

It may sound strange, but the objective here is to actually “spend” all our Income.

To my surprise, this technique is used in corporate finance as well. Due to the more sensitive nature of a business, ZBB is a more iterative process when compared to its application in a personal finance scenario.

Year over year (last day of September), I can notice the improvement. So far, I managed to save roughly 6800€ more, and I still have three months left.

I feel I will hit my 2020 savings goal very soon…

Everyone can try this different approach to budgeting, even regular budgeters. While it may not be a radical change, I feel it enforces more discipline.

Below are the steps I consider essential when building a Zero-Based Budget:

1. Start with The Income

In my case, as my monthly Income is variable, I was forced to start each month with a new budget limit.

Total Budget = Total Income

Psychologically I felt that it help me to restrain some expenses on lower-income months.

It makes total sense!

I’m supposed to spend less on all the variable expenses while keeping a fixed budget for savings/investments.

2. Define All Your Monthly Expenses

This second step requires that you have concrete knowledge about your expenses. On top of the running expenses, all the savings/investments are now considered an “expense.”

As I already had quite some data from 2019, I have set up the following categories of expenses:

  • Housing (Mortgage, Rent, Utilities)
  • Loans (Monthly Debt Repayments)
  • Savings/Investments
  • Transportation (Fuel, Maintenance, Insurance)
  • Daily Living (Groceries, Personal Care, Clothing, Vacations…)
  • Health (Consultations, Pharmacy)
  • Entertainment (Events, Nights-out, Gifts)
  • Miscellaneous

For each category, I defined a total budget.

In the case of a category composed only by fixed expenses (Loans), the budget is easy to attribute.

Category Budget = Total of Fixed Expenses + Total Variable Expenses

3. Decide on a Buffer

For variable categories such as Daily Living, the allocation is trickier and requires past information. On top of that, I added a 5% buffer to deal with unexpected events.

A practical example is Health. For me, this includes pharmacy costs and doctor appointments. As I cannot possibly predict how many times I will be sick, my monthly budget was based on what I spent in 2019 divided by 12 months.

A known fact is that stuff always comes up!

Preparing a reasonable buffer based on our own data does make sense. I found that a 5 to 10% buffer depending on the category, did work for me.

4. Subtract Income from the Expenses

We want the result of the Zero-Based Budget (ZBB) to be a big zero. When this is done for the first time, generally, the result will not be zero as we wish.

ZBB = Expenses — Income

Either the value is negative because we did not consider all the categories carefully, or the end result is positive due to excessive expenses.

In that case, make sure to review the budget for each category. Each category total has to be tweaked so we can end up with a value very close to 0.

Normally, 2 or 3 iterations are enough to come up with a zero. However, this is only a plan. As the month progresses, we may need to adjust the categories but not the total budget.

5. Track Progress Throughout the Month

While we might believe that everything will go according to the plan, that will only happen if we track our progress.

This is where a tool such as Excel or Google Sheets can help. I use Google Sheets, and it fits my requirements. I feel I have better control, and I can keep improving/tweaking my tracking capabilities and build dashboards with relevant graphs, like the one below.

Zero Based Budget Example

Other apps may work as well and may provide a more intuitive interface from a mobile device.

6. Check for Improvements

After using the methodology for quite some time, there is always space for improvement.

When I notice some categories are always under or over budget, I try to understand why that happens. It can either be because I consistently overspend and need to see why, or I might have a budget mistake.

You may ask yourself:

Am I overspending in this category? What happened? How much was the difference? How can I avoid such a gap next month?

Ideally, the amount remaining in my checking account would be around 0 but as the month progresses, I get visibility if that will be the case or not.

A Final Touch

Budgeting, in general, does work and I see value in keep doing it. For some people, it does not independently of the technique in use.

A Zero-Based Budget is even more aggressive than a traditional budget since it makes sure every cent of your income is accounted for.

I see it as a commitment to my personal finance and I enjoy tracking my progress. It keeps me motivated and provides me a real insight into how I am spending my hard-earned money.

Thank you for reading and hope I contributed positively to your day!