If you have tried to reign in your spending and get control of your unwieldy household finances, but still the credit card balance and other loans are heading upwards, you might be ready for a tool many governments and companies have used successfully – zero-based budgeting.
What is zero-based budgeting, and how can it help you?
First let’s take a look at the problem. Whenever it comes to cutting back on expenses, it is hard. It is psychologically hard. It is emotionally hard. Cutting back implies reducing, and it is always hard to reduce. Some things cannot be easily reduced (such as the mortgage or the costs of commuting), and other things can, but with a huge emotional price (dessert, movies, etc.)
Zero-based budgeting removes the reducing from the equation. Here is what Wikipedia has to say on the topic: “During the review process, no reference is made to the previous level of expenditure. Zero-based budgeting requires the budget request be re-evaluated thoroughly, starting from the zero-base. This process is independent of whether the total budget or specific line items are increasing or decreasing.”
So you start with a blank page and say, “What do I absolutely need to spend on this month?” You might already have a list of monthly expenditures that are pre-authorized, such as car loan payments or municipal taxes or mortgage or rent payments. You might as well start with these.
Make no mistake, you can change these things through debt consolidation, finding a cheaper apartment or extending the length of your mortgage. And these might be appropriate strategies for you. But that does not change the fact that this month they need to be paid.
Then you need to add those things that you cannot do without and cannot control the costs. Heating, electricity and water come to mind. Again, you can choose to make some lifestyle changes that involve warm sweaters, dark homes and weekly showers; these would reduce your expenditures. But you still have to budget enough to cover the utilities that you do consume. Minimum payments on credit cards and other debt fall into this category.
Next, you should budget for what you need, but can more easily control the costs. Food is a fine example, because you do need to eat. But, do you need to eat Brie cheese? Do you need to eat desserts? Set yourself a modest budget that covers the food you really need. We’ll get to the luxuries later. The same goes for clothes. And toiletries and cosmetics and such. Budget for what you actually need this month – you can’t go to work with holes in your shoes, but a third pair of black shoes might well be able to wait another month or even a year.
Now here is the important part for those people trying to tame a runaway debt. You are left with what is called discretionary income. You are legally and logistically free to spend what is left in any way you want.
And if what you want is to be free from debt and have more money to spend on fun things in the future, you should allocate as much as possible of that discretionary income to debt reduction. If you are a highly disciplined person and you can hold your breath for three months or six months (watch TV instead of movies, read library books instead of buying new books, skip desserts that just make you fat anyway), you can very quickly pay down a whopper load of debt and free up those credit cards.
The result? Not only can you return to buying luxuries, but your loan an credit payments will be reduced so that you can afford that cruise you were thinking about the following year.
And you did not do it by cutting costs. You did it simply be not deciding to make luxury expenses.
Of course, you do not have to go cold turkey on expenses. You can choose, for instance, to apply half of your discretionary spending to debt reduction and the other half to treats. Just make sure that whatever your budget, you stick to it.