What is a Zero Sum Budget?
A Zero Sum Budget is where you allot every penny of income, essentially leaving you with zero money in hand at the end of the month.
How Does a Zero Sum Budget Work?
Well, let’s say that your net income for the month is $2,000 dollars. After writing down each expense for the month, your cash on hand looks like this:
|Category||Amount of Expense|
|Emergency Fund / Investing / Etc.||$400|
$2,000 income – $2,000 ($1600 + $400) in expenses = $0
So, you’ll earn $2,000 for the upcoming month, but your total expenses for the month will only amount to $1,600 for the month. Your job, in a zero sum budget world, is now to figure out ahead of payday what you’re going to do with that extra $400.
In a zero sum budget world, every dollar that comes into your pocket has an established destination. So, with your extra $400 for the upcoming month, you now have some decisions to make.
Will you sock extra away into a retirement vehicle such as a Roth IRA (this scenario assumes that your company 401k is a part of your pre-tax expenses)?
Will you invest some of the extra money in a non-retirement investment?
Or maybe you’ll sock it away for an upcoming future expense, such as a home purchase or a replacement vehicle purchase.
The goal, you see, is that the money isn’t just left lying around, without a purpose, in your checking account.
Why not? Because money without a purpose will almost always disappear on something wasteful or unnecessary.
Money with no purpose often ends up being whittled away on lattes, dinners out and other non-essential items that you hadn’t planned on spending in your initial budget breakdown. What can that “lost” money mean? Let’s do a “what if” scenario.
What Happens to Money Without a Purpose
Let’s say that you, instead of letting that money sit around, waiting to be spent, put $200 of that extra $400 into the S&P 500. The S&P 500, over the last 10 years according to Morningstar, has averaged a 7.82% return. If you were to take that $200 a month and put it into the S&P for ten years, you’d have in your investment account $36,790, gaining you $12,790 in interest accrued.
Or, you could just leave that $200 a month in your account to be piddled away on stuff you’ll never remember in ten years. What if you invested the whole $400 each month in the S&P?
You’d have $73,581, or, a profit of $25,581 sitting in your pocket. Or, you could enter year 10 with nothing to show for your extra cash but a latte addiction and some really cool clothes that have long since worn out.
Budgeting is definitely personal, and I’m a huge advocate of value-based spending; spending your money in the way that most fits with the values you hold dear in your life. But how much money do you earn that simply blows away in the wind because it doesn’t have an assigned purpose?
That, my friends, is the question. You need to budget for the categories that are important to you. And for maximum value on your hard-earned dollars, a zero sum budget is the answer.
Do you use a zero sum budget? What is your favorite budgeting tool?