Budgeting is an incredibly popular topic among the financially savvy. And yet some of the most financially-savvy people I know don’t actually budget. With zero based budgeting, there’s no longer any excuse to avoid a budget.
When you think about a budget, what do you think of? You might think of having umpteen different categories to divide all of your expenses among. Each time you make a transaction, you have to decide which category to put that expense into. And then what happens if you over-spend in one category? You have to decide which other category that expense comes from.
This can get really complicated really quickly. In fact, you could wind up spending hours and hours each month just managing your budget. I, for one, don’t have time for that!
Instead, I use a practice I call reverse budgeting. It can also be called zero-based budgeting.
Here, we’ll talk about how this works for me, how it might work for you, and some tools you can use to make it work.
How Zero-Based Budgeting Works
You may have heard about this type of budgeting from financial guru Dave Ramsey. Except he uses it to describe this incredibly detailed, category-oriented budgeting system we talked about above. That’s one way to do zero-based budgeting, but it’s not the only option.
At its core, zero-based budgeting is actually about subtracting all your expenses, savings, and goals from your total monthly income and coming up with a difference of zero. There are actually several different ways to make this process work for you. Let’s talk about the options, and then figure out what might work best for your particular needs.
Option 1: Percentage-Based Budgeting
This is the option my family uses. Frankly, we have too much on our plates to spend loads of time examining every purchase. Instead, we devote a certain percentage of our income to savings goals each month, and then spend the rest. We can basically spend up to what we devote to spending, and no more, since we don’t do debt.
For instance, you could decide to devote 20 to 30 percent of your total monthly income to savings. You might split this between long-term goals, like saving for retirement, and shorter-term but necessary goals, like saving up to replace your vehicle. Then, maybe you’ll save 10 percent of your income to pay for one-off expenses, like getting your tires replaced or dealing with home repairs. Then you can spend the remaining 60 to 70 percent of your income on your daily needs and wants.
This is a very loose way to go about budgeting, but it works for a few reasons:
- It’s easy to maintain. When you’re just shifting money around to savings accounts on payday and then keeping track of your balance, you don’t spend hours maintaining your budget. You can spend more or less in certain categories, as long as you don’t wind up going into debt.
- You pay yourself first. One of the first principles of personal finance is to pay yourself first. This means you need to save before you start spending. This type of budget has aggressive savings goals, and you start saving right away.
- You can use it to get out of debt. If you’re still working your way out of debt, this type of budget can still be helpful. You can, for instance, set aside a certain percentage of your income for savings, but then another percentage for extra debt payments. Outside of those categories, you can spend what you need to spend.
- We’re still frugal. We could maybe save a few extra bucks a month if we more carefully tracked our budget down to the penny. But we’re still pretty frugal, especially since we have high savings goals. By putting a bunch of money into savings each month, we force ourselves to live on less. And as we’ve gotten pay increases over the years, we’ve been able to devote more and more to savings rather than falling prey to lifestyle inflation.
- It’s easier for a variable income. If your base income varies or you have a side gig that brings in varying amounts of money each month, this is an easier option. Category-based budgeting can be tough when you don’t know exactly what your income will look like from month to month. With this option, you know that no matter what your income is, you save a certain percentage. And then you spend the rest. If your income is really variable, set up a system where you save extra in flush months to cover additional expenses in lean months. And consider lowering your savings percentage when your income for a particular month is really low.
With that said, this option isn’t for everyone. Some people need or want a much clearer picture of where their money goes every month. So here’s the other way to work a zero-based budget.
Option 2: Giving Every Dollar a Name
This is the budgeting option espoused by Dave Ramsey and his followers. And it’s not a bad way to budget. Basically, you start out the same way–with your total monthly income. But instead of just assigning a percentage to savings and the rest for spending, you detail your entire spending plan.
This means budgeting by category for things like your house payment, utilities, grocery spending, dining out spending, money for clothing, savings for holidays and birthdays, and more. You can get as broad or detailed as you want, though Ramsey’s budgeting templates are pretty detailed by category.
The goal here is to give every dollar a job before the month even starts. When you’re first starting out, you may find you need to move money from one category to another frequently. Over time, you’ll get more familiar with what you actually need to spend in each category on a monthly basis. But if you’re restricting your spending in this way, you shouldn’t ever need to spend more than you make.
Here’s what’s good about this more complicated budgeting option:
- It lets you know exactly what you’re spending. A zero-based budget tries to be prescriptive. That is, it tries to tell you what you should be spending in each category. But at first, you might be off base. As you track your expenses carefully, you’ll know better what you’re already spending and where you need to make adjustments to live frugally.
- It’s great for becoming debt free. If you’re dealing with a lot of debt–especially if that debt is due to your own over-spending–this may be the budgeting framework you need. Yes, it takes more time. But it also keeps you more closely in touch with your spending so that you can find ways to become debt free more quickly.
- It helps with projections. A very detailed budget can help you know not only what you are spending now but what you’re likely to spend in the future. When you’re careful to plan for expenses that are a few months out, you’re less likely to be stuck without enough cash in hand to cover those expenses when the time comes.
Option 3: A Hybrid Approach
What if you know you over-spend in some areas but don’t want to spend an hour every week controlling your super-detailed budget? In this case, a hybrid approach may make sense for you.
In this approach, you’ll still devote a certain percentage of your monthly income towards savings and short-term goals. Then, you’ll set a couple of categories to track your spending money.
For instance, maybe you have a problem over-spending on your kids’ clothes because you just can’t resist a good sale at Old Navy or Children’s Place. You might seem frugal because you’re only shopping sales. But at the end of the day, the kids have too many clothes, and you’ve spent way too much on them. In this case, track spending on your kids’ clothes for a few months, and see when and where you need to cut back. Just the act of holding yourself accountable for that spending can help you cut back!
Or what if your problem area is spending on food? Track all of your food spending for three months. Then decide if it’s too much or if you can cut back. If you dine out a lot, just seeing how much you’re spending on those trips to the restaurant can help you decide to cut back.
This budget approach is great because:
- It doesn’t take as much time as a detailed zero-based budget. You can spend just a few minutes a week totaling up spending in those chosen categories, and otherwise just spend what’s available to spend.
- It can help you become more frugal. If you’re struggling with over-spending in just a few areas, this option can quickly help you get that spending in check. You may find that you suddenly have more money for things that are actually more important to you, or that you can pay down debt or save more quickly.
Tools to Get it Done
No matter which of these zero-based options you choose, there are some great tools to help you deal with your budget. Here are a few that work really well:
Free Bank Accounts
Yes, this counts as a tool! This is especially true if your spending plan involves moving money around on pay day. Say you’re trying to save 20 percent of your income. On payday, you should be transferring that much straight out of your checking account. When your accounts are free, it’s much easier to maintain this option.
The best online savings accounts can also help if you want to divvy up your short-term savings goals. Maybe some of the money is for an emergency fund, while the rest goes towards vacation savings. Having a different account for each can let you keep track, at a glance, of where you are on your savings goals.
And this can also work for the hybrid budgeting idea. Say you want to restrict your spending on the two categories we mentioned above: clothing and dining out. Set up a checking out for these expenses, specifically. On payday, transfer the percentage or dollar amount you want to spend on these categories to their own checking accounts. Then, you’ll be restricted in the amount you are able to spend unless you dip into your primary checking account.
Online Budgeting Programs
Online budgeting programs have come a long way since we originally published this article in 2008. Now, you can easily import transactions in programs like Mint.com and YNAB. Sure, you have to spend a bit of time categorizing your transactions. But this is helpful if you’re doing a detailed budget or just tracking spending in a few categories.
Resource: Our list of the best budgeting tools
Want to go old-school? Use a spreadsheet to track your percentage of savings and spending over time. You can even create a chart to show you how your savings is growing, and how much money you’re spending month to month so that you can figure out if you need to cut back.
The point here is that zero-based budgeting is a great option for most budgeters. Whether you opt for a super detailed plan or a very loose one, this type of budgeting can help you make the most of every dollar and reach your financial goals.
31 Responses to “The Fine Art of ‘Reverse Budgeting’”
My wife and I do this. We have enough automatically transferred to various savings, such that if we spent every penny that makes it into our checking account, we would still be making good progress. We rarely spend all the money in our checking account either – every few months I notice a surplus has built up and transfer a little extra to savings.
I have yet to fund budgeting software that’s effective. The programs try to do too much thinking for you and unless you take the time to categorize every expense, you’re not going to get much out of it. Even then, the software programs just give you a general projection for the year, not a specific spending plan for each month. It’s important to do a new budget each month because every month is unique and has different income and expenses.
Here’s a link to the free budgeting form I mentioned in my post above. There are more free resources there on my site at financialexcellence.net but this form is the foundation for everything else. I’ve used this form for years and it has helped our family stay accountable to our own spending plan each month.
The most effective budgeting method I’ve found (and I teach budgeting for a living) is the zero based budget. I see some posts on here of folks having trouble with maintaining the zero based budget. I have some cash flow planning forms on my website under the free resources tab that may be useful for you guys. These are the forms we use in our home. They have columns to list your plan, track your actual spending, and check the % of take home pay for each category.
Hope that helps!
I’m surprised no one has mentioned this article:
The 60% solution is a great starter article on this topic. I use a variant of this. I do agree that it is better when you have more income. But then again, I have used this method since I was just out of college eating Ramen everyday. I feel I get 99% of the benefits of detailed budgeting with 0% of the hassle.
i’m very happy to hear about this type of budgeting, i have never budgeted before and since i have become a stay at home mom with only my husband working, i figured we needed to be more money management savvy, especially with savings, he gets paid well, but we are constantly playing catch up with our bills, never pay them in time. so most of the money he brings home is just for paying the bills we owe from the previous month, i have figured out how much we need a wk to save for the month to be able to send them out for the 1st. i just don’t know where to begin, i will be receiving my taxes soon, hoping that through that cash we will be able to get everything paid on time (everytime), so how do i start my reverse budgeting after all this is set and done, how much should i take out of the (extra) money after i take out what we need for the wk to put away for the bills???
I do a different sort of reverse budgeting. My wife and I both work full time, I get paid every week and she gets paid every other week. So what I have come up with is a complete bass ackwards way of budgeting. I pay all the bills that are due either when it gets close to their due dates or if it happens to work out for us to pay the bill collector that week. We do have the usual credit card debt, but we pay the minimum payments, hold on I know about snowballing and snowflaking and all that, I’ll get to that in a min.
After all is paid up for the week, I work it so that i leave ourselves with between $100-$200 for our usual weekly spending. Then, I take what is left over from out “allowance” and throw the extra at the credit cards.
I do have the CC’s organized by order of highest APR to lowest and we are just starting this getting out of debt thing, so i don’t feel that any savings is necessary right now. it is on the goals list, i just want to knock down some debt first, which is also the first step in getting out of debt for us. Cheers!
I find the concept of reverse budgeting enlightening and though provoking. I can see where the zero based budget is time consuming and you really must be into looking over the numbers all the time to keep up with that concept. But the to use the reverse budgeting would free up the time spent on the zero based budget.
Absolutely reverse budget. It’s how we decided on our house, etc. We reverse budgeted our 401k, Roth IRAs, taxes, etc. This way we prioritized what was important and then picked a house based on what we thought we could afford.
But I also track our spending to see how we’re doing. And while it’s not fantastic, we don’t overspend. I can see definite areas we could save more, but I question if it’s really worth it.
I really like the idea of the “reverse” budget. Although we have ‘targets’ for many categories, I found I was always borrowing from one category to pay for another, all balancing so I would not have to touch the amount I wanted to save.
I was just reviewing my budget for the month, as well as checking to see how closely I came to meeting my budget for the last two months. After I ran all the numbers on my savings goals, plus some of the money that I “owed” to myself, I still ended up with a surplus of over $10,000 (and this doesn’t count our emergency fund).
So I’m wondering: does it really matter if I met my budget, as long as my savings and investing goal are met?
My budget is set up to be very fluid. I review it at the beginning of the month and divert any non-regular, large expenses from my extra payments to any debts. I also save monthly for annual expenses, such as insurance (home, auto, life x2, umbrella), Christmas, taxes, etc.
Living below oneâ€™s means is KEY to this program.
I started on this method of budgeting with my first full time jobâ€¦that paid next to nothing. It has worked FABIOUSLY for me but getting started did require some rough calculations to determine what % of my salary was a feasible amount to save. My savings account is treaded like a nice second landlordâ€¦once I pay the rent I never see it again. (I say nice because some times my savings account lets me â€œpostponeâ€ payment if something drastic came up)
The best part of this program is now the only time I have to look at where I spend my money is when I want to buy something price and need squeeze some dollars out of my
â€œconsumable cashâ€ . Instead of taking extra cash out of my own pocket, I take it out of the grocery storeâ€™s, or the cable companyâ€™sâ€¦you have to get creative but some times you want the new designer swimsuit more then the $30 weekly night out with girls.
It does work.
I have pondered the this idea, but with a twist. I have the money that I can spend and leave it the bank that my check is deposited into and then I put the rest of the money in an online only account that I don’t have a debit card to or checks.
With this second account I can pay my bills online. Most websites don’t require a card just a routing number so this seems like it would work, and for those places that do need a card number then you can leave that amount in the first account and pay it quickly.
I would just need to stop being lazy and do it. It looks good on paper at least. What do you think.
Planner, you’re correct.
Nickel, good question. Judging from what’s happened to our finances the past few years, if I’m going to spend organically, I’m going to need to get a lot more of my income out of my reach. I tend to spend more without a detailed budget than with one (even if it’s just one category of spending), so overcompensating with the saving offsets this extra spending.
In response to James.
Something I started doing with my savings, which is partially influenced by the principles taught in the book The Richest Man in Babylon, was having two savings accounts. One where 10% of my income went to serve the purpose of only making more money. This account has not been used to help buy a car or a new piece of furniture (as much as I have wanted it to). The second savings account I also put 10% in but with the purpose of saving up for cars, furniture, vacations, or anything else my heart desires. So far this has worked great for us (we don’t feel guilty about spending the money), but takes some easing into. But if you’re already saving 20% it shouldn’t be too hard to adopt.
Unfortunately, I don’t have enough wiggle room after I pay all bills (including $$ to a 403b) to be able to save (aggressively or otherwise)!
After my cc debt is gone (by this October, I hope) I’ll be able to add a little flexibility in terms of saving/investing.
This month I’m experimenting with a zero based budget (you can see this on my blog), so we’ll see how that goes. I’ve found that I really do need the structure of a budget (even if I don’t follow it exactly), otherwise my money runs through my fingers like water. . . .
I had never really been able to get a grasp on my finances. To the point of never having savings and living paycheck to paycheck. But when I set aside a specific percentage each month (10% of what I grossed) in a fairly accessible but not too easily accessible money market account, I began living within my means and getting a nice little goose egg while getting better at paying off debt. I now have no more credit card debt and usually end up with excess in my checking account each month. I feel like a commercial, but reverse budgeting has really worked for me. The biggest thing it helped me do was live cheaper, which ends up turning into living nicer without the burden of debt. Do it.
My wife and I were using 0 based budgeting but found that the maintence of inputting all the data became too much of a drain. (We live in NZ and don’t have sites like Mint yet)
We switched to what I now realize is a reverse-budget where we direct 20% of our combined after-tax income to a seperate savings account.
What I’m wondering is how everyone handles expenditures that exceed monthly pay? Let’s say you want to buy a car and put $10,000 down, do you draw from savings, or try and conserve the “left over” until you’re at that mark (which isn’t always feasible as sometimes you need it sooner than later).
It seems like the more aggressive the savings plan the more likely you’ll have to go into it to cover this capital expenditures…
Anyone have any strategies?
My wife and I are trying to save 3k per month after taxes in taxable accounts. Pre tax we are doing 20% plus employer match and then funding IRAs. Also i put 8% into employee stock purchase plan which is basically my new car/fun money for the future.
I think my answer to this is no, I don’t budget now, or plan to do a detailed budget in the future.
After working on debt reduction I plan to try the 60%/40% budget that I am sure many of you have heard of. A few tweaks for my personal preference of saving a bit more than 10% for retirement and others.
I know this is not a budget in the true sense of the word, but I can check my spending allocation for the 60% periodically by looking at a sampling of the last month, and as others have pointed out, my time is worth money as well, so I don’t want to spend it budgeting!
Link to the 60/40 budget basics on MSN Money who as far as I can tell were the first people to post this budget: link
I work aspects of this into my budget… As each hour of my time costs more and more, it becomes a better method of budgeting rather than investing hours on hours to save $15 a month… Good post…
Actually I also wrote a post about my thoughts on this not long ago. It is here if you care to read it.
The 30% number seems to be mbhunters “aggressive” goal, probably a few notches higher than mb is achieving.
I use a method similar to yours. It works for us, like you, because we do have savings goals that we meet. One other thing that works well for me is reviewing summary totals each month. At that point it is close enough to dive in if needed, but quick enough to record every month to watch trends.
Toby: If you do things this way and feel as if you are overspending, then the answer is to increase your savings targets. Note that I said we have “aggressive” savings targets. As our income has increased, we have increased these both in terms of actual dollar amounts and in terms of percentages.
mbhunter: Yes, I keep track of expenses in Quicken, but I rarely look at that aspect of the data.
As for how much you’d have to be saving to feel comfortable doing it this way, ask yourself how much money you are setting aside with a detailed a budget. That’s a good place to start. Is the 30% number that you tossed out more than, less than, or the same as what you’re currently saving? If it’s more, then I’m curious to know why would you hold this approach to a higher standard than a regular budget.
I found that doing it this way didn’t really work, but it may work better if you shunt a lot of the discretionary income (as in 30% or more) into savings. At least that’s the percentage I’d need to save in order to feel comfortable with your reverse budgeting.
Do you track expenses at all?
We’re certainly trying to follow a budget very closely until we can get a handle on living frugal. The last 10 years we just didn’t do so well w/o a focused plan. Perhaps once we are sure we’ve completely adopted the lifestyle we could try a more relaxed approach with the same result, but I’m not betting on that for now.
I have been using a budget for about a year and it works great for me. I always saved some money before that, so it wasn’t that I “needed” a budget to get out of debt or anything. But I just decided that I wanted to know where my money was going and figure out ways to cut more and save more. Using a budget gave me a reality check on how much I was spending on “frivolous” categories such as dining out, new clothes, etc. It also makes me conscious of every penny I spend. I am saving much more now and tracking my spending keeps me in line.
I’m with Saving Freak. I budget the exact way you describe. We have our savings/investments pulled out automatically and the rest this amorphous blob of cash that can be spent on groceries and gas or just as easily on designer towels for the guest bath.
The problem with this, I am realizing is that the amorphous blob is bloated and I *could* be saving more of it if I tried. We are generally frugal, but somehow almost every month the blob is consumed.
The reason I know we could do better is that recently, I’ve realized it is time to replace the computer. After discussing it with the wife we tightened our belts in January and squeezed $400 out of our spending in the past month to save towards the computer. That’s no small bit if change.
Where is this $400 going every month? I need to analyze our spending to get a better picture but it’s clear that not all of the amorphous blob needs to be used up every month.
The only problem I see with this system is you will never really know if you are overspending in a category. It may not matter in your individual cases since you are able to save a significant amount anyway. However many people have no idea what they are spending on food, entertainment, etc. Without doing a detailed budget they may never know and thus never change their problem spending.
We also budget in a very similar way. Most of our investments are automated, so we “pay ourselves first”. I maintain a very simple profit and loss statement each month in Excel showing (net) income, expenses and investments. There are only a few variable entries each month and we have very few line items (we lump credit card, cash and checks in to one line). We have 3 young kids and are pretty frugal, so I’ve never seen the point (in our case) in having a detailed budget. The P&L statement just gives me a bird’s eye view of how we’re doing and whether adjustments are needed. I can look at an entire year with running totals on one sheet, with different tabs for prior years. Works well for us and requires little time.
One of our 2008 goals is to finally come up with a 0 based budget. But, last year and so far this year we really use a spending plan. We pay all our fixed and semi fixed bills then we put money towards our 2008 savings goals and we live off (groceries, dining out, clothes, gifts, entertainment) off the remainder. When the money is gone we stop spending.
Yeah, this is pretty similar to how I “budget”. I set aside a fixed amount to spend every month, and save the rest, and I don’t plan or even care too much about how it is spent, as long as I don’t go over the fixed amount.
Arguably, this approach may really only be workable for those with decent income and enough left over to save a meaningful chunk and still have fairly comfortable spending allocation. For lower earners where every dollar counts it is more necessary to set up detailed budget, IMHO.