Zero-based Budgeting: How to Stop Living Paycheck to Paycheck

78% of full-time workers in America are living paycheck to paycheck. And it's not just "poor people". People making 100k a year are as well.

Everyone is broke, even people who "look well-off". Big home and nice car? You can't assume they actually have any kind of savings or plan for retirement. They are likely drowning in debt and unable to pay for the simplest of emergencies with cash.

What does it mean to live paycheck to paycheck? It means that at the end of every month you have no money left over. It might even mean that you are living beyond your means and spending money you don't actually have. And so when an "emergency" happens like a tire blowing out you have to put it on credit. But tires blowing out are not an emergency. They are predictable.

Most financial "emergencies" are not emergencies. Christmas is right around the corner but you have to put everything on credit? That's not an emergency. Christmas happens every year at the same time - it's perfectly predictable. Regular auto maintenance is predictable. Your yearly Amazon prime subscription is predictable as well and is not an "emergency" just because you forgot to budget for it.

But in order to turn these "emergencies" into stress-free situations you already have money put aside for, you have to start budgeting. More specifically, you need to start a zero-based budgeting system.

Here's a simple way to do it, called the "envelope system".

Let's say you have $1,000 in your checking account.

First step is to cash it out.

Then you need to assign each dollar a job by putting the money into different labeled envelopes.

The first step is to cover immediate obligations coming up that need to be paid.

Rent is due next week. So put $500 in an envelope for "rent". That money in that envelope has now been given a job: its job is to pay for rent.

You also need some gas to get to work tomorrow. So throw $20 in an envelope for "fuel".

You also need some groceries. So put $100 in an envelope labeled "Food".

You keep doing this until every dollar of the $1,000 you actually have is assigned a job.

If you run out of money but still have things you need to budget for, you're going to have to wait until your next paycheck or cash inflow.

The key to zero-based budgeting is you want your inflow of money to always balance zero with your outgoing money. So every dollar needs to be given a job. You should never have money to your name but no plan on what to do with it.

Now, what about those rare but predictable expenses like Christmas and auto repair? Once all your immediate obligations like rent, gas, food, and utilities are taken care of you need to start setting aside a small amount of money each month in envelopes for "Christmas", "Car repair", "Amazon prime", "Yearly taxes", etc.

It's also useful to have a separate envelope for things you forgot to budget for, a "misc" category in essence. But if you keep forgetting something you need to create an envelope for that category. Over time with trial and error you should minimize the things you forgot to budget for.

When you have finally covered all your immediate and irregular budgeting categories, you might have some money left over. What do you do with it? Here's the fun part: anything you want!

But it's probably wise to start saving. First step should be to create a emergency fund that covers 3-6 months of expenses. Once your emergency fund is in place, you can start saving for whatever it is you want to save for: retirement, college education for your kids, a new car, paying off your debts, etc.

Now that your money is under your control you can start planning for your future. That's what true financial security feels like: knowing the future is taken care of.

And that's how you do zero-based budgeting!

Right now you're probably asking, "What if I don't want to use cash?"

No problem! There is an amazing software system called "You Need a Budget" or "YNAB" as it's known that basically does the exact same thing as the envelope system. It connects to your bank accounts and you assign every dollar you actually possess a job, just like the envelope system. The goal is to make the balance between inflow/outflow "zero".

Why does this work so well? Because it forces you to budget based on the money you actually have as opposed to the money you might be getting in the future. If you are pretty confident that you're going to get a $1000 paycheck two weeks from now you might be tempted to create your budget based on your future predicted income. This is a mistake and quickly leads you to spend money you dont actually have, which perpetuates the phenomenon of living paycheck to paycheck.

Zero-based budgeting forces you to budget based on the money you actually have as opposed to future money, which doesn't actually exist. This will force you to be more conscientious with your money and basically "triage" your money based on what's actually important.

After a few months of zero-based budgeting it will be like you were given a raise. You will have more control over your money. You will break the cycle of living paycheck to paycheck and feel financial freedom like you never have.