Zero-based budgeting might work for some people, but there is a much better alternative for almost everyone.
Before I go further, let’s look at what zero-based budgeting is.
Quite simply, this is a process whereby you account for every single dollar you bring in. You budget every penny. You budget some money for spending and other money for saving. Nothing goes unaccounted for. You can use budgeting software or a spreadsheet to set this up.
I know that this system helps many people, but it would drive me (and more important…my wife) nuts. It’s a bit too regimented for us. We’d never stick to it. And my experience tells me that lots of people feel the same way.
Sure…lots of folks start off with good intentions. But after a short time, the work becomes too much. The burden too great. Out goes the baby with the bath water and we’re back to our free-spending ways.
Actually…the situation for many of us gets worse. Having gone through this exercise with 100% commitment, we get discouraged when we see it’s too much. Unfortunately, some people decide that they are doomed to a life of debt because this last-ditch effort failed so miserably.
Is there a better way than zero-based budgeting?
In a word…yes. Just pay yourself first and then spend as much as you like after that. In other words, create a financial plan. Then you know how much money you need to save in order to reach your goals. Add in an expected rate of return and calculate how much money you need to save each year to stay on track. If that number is too great, amend the plan.
How? Either work longer, retire with less or work part-time after you retire. This entire process is built around knowing one thing: How much money do you need to retire?
I’ll give you an example. I’ll ignore inflation, taxes and interest for the time being. I just want to show you how this works. You can find financial calculators on the web to determine present and future value. Let’s say you’ll need $25,000 a year (on top of your other sources of retirement income) to live on when you retire in 10 years.
If you figure you can withdraw 5% of your money when you retire, that means you’ll need a total of $500,000 at that time.
If you already have $200,000 saved, that means you need an additional $300,000. You have 10 years to save that money so that means you must save $30,000 each year. To keep things simple, assume you will earn nothing on your savings over the next 10 years. You need to save $30,000 a year for each of the next ten years.
$30,000 a year is $2,500 a month. So for this plan to work, you must save $2,500 each month before you do anything else. If this is doable, do it. Then, spend everything else. No problem.
But let’s say you can only save $1,000 a month. No problem. Amend your plan by either reducing your cost of living, working (and saving) longer, working part-time or a combination of all three.
Can you see how such a plan might be far more powerful for you than a zero based-budget? With the zero=based plan, you might become a great accountant…but that doesn’t mean you’ll reach your goals.
I love this system because it has a great foundation:
a. It’s built on reality.
b. It’s focused on my goals.
c. I know immediately whether or not I’m on track.
d. It’s simple.
e. I pay myself first.
With this type of plan, you are goal-oriented. Plus, it’s a lot more fun. Once you reach your savings goal, you can do anything you want with any money left over. Blow it in Vegas? Go ahead. Buy that X-box? Be my guest.
Would this budget planning process work for you? Why or why not?