Zero-Based Budgeting + 1% Rule: A Simple Recipe For Financial Success

How many people do you know who struggle to save or invest? In fact, they live from paycheck to paycheck. I know many who run out of money by the 20th of every month and then either borrow from friends or depend entirely on credit cards to get by. It’s a struggle for them to make ends meet comfortably, let alone think about investing.

The remedy?

The two very basic rules that can turn this financially and emotionally stressful situation to a prosperous one are ‘Zero-Based Budgeting’ and ‘Rule of 1 per cent’.

Let’s understand these two rules with the help of a fictional character named, Karan.

Zero-Based Budgeting

Earlier, Karan used to save whatever was left at the end of the month. Some months, it was Rs 1,000, some months it was Rs 1,500, and sometimes there used to be no savings at all.

His savings were irregular, his expenses were happening on autopilot, and he never really knew where his money went.

This is where zero-based budgeting came to Karan’s rescue.

Unlike regular budgeting, where you set broad limits for your expenses and hope to spend less than you earn, zero-based budgeting assigns a specific purpose to every single rupee you earn right at the start of the month.

It simply means that every rupee has a job, whether it's for rent, food, or even savings. Nothing is left idle or floating around for impulsive spending. For instance, Karan’s take-home salary of Rs 40,000 should be divided at the start of every month in a way that every single rupee is accounted for and its use is transparent.

So, in his case, he had to pay for food, house rent, travel expenses, loan EMI, health insurance, outings with friends, payment to house help, and begin investing, etc.

So basically, you plan in a way that your income minus your expenses minus your investments equals zero.

And here's the best part: every month the plan starts from scratch. Zero-based budgeting is not a fixed template. You will have to do it as a monthly ritual right from scratch. So, suppose in some months you have to pay for your Wi-Fi subscription or mobile pack, or make arrangements for a gift to your cousin for her wedding, etc. You can accommodate all kinds of expenses since you won’t be working on an outdated template, but from scratch every month. This will actually help Karan channelise some portion towards investing every month.

Now, this basically helps you stick to your monthly budget in a disciplined way, provided you do it every month without fail.

1 per cent Rule of Investing

Along with creating a fresh budget every month, you also need to try to increase your investments on a regular basis to be able to achieve your monetary goals in the long run.

This is where the 1 per cent rule of investing comes into play.

Now the 1 per cent rule is simple. Going by the rule, you just have to cut down your spending by 1 per cent every month and add that same amount to your savings.

But well, it may not be possible for Karan to reduce his monthly expenditure on some basic expenses like food, the rent that he is paying, his insurance premium, etc. To make this rule work for him, Karan broke his expenses into two categories – fixed and variable.

In the fixed category, he added expenses that are unavoidable and cannot be reduced much, like house rent, loan EMI, his monthly health insurance premiums, and payment to house help.

So, suppose out of his take-home pay of Rs 4,0,000 per month, total fixed expenses came out to be 25,000 rupees, that left him with 15,000 variable expenses like groceries, eating out, transport, weekend  entertainment spend and various subscriptions, etc, and this is where he applied the 1% rule.

So every month, he found small ways to trim his expenses by just 1% so in the first month, he had to reduce his expenditure by Rs 150. Karan could easily achieve that by cancelling one of his unused monthly subscriptions to an OTT platform and cutting down on eating outside more often.

For the next month, he plans to start sharing rides with friends to the office every now and then, and so on.

So by making these small tweaks in his spending habits, he added Rs 1,700 more to his mutual fund SIP kitty in the next 12 months.

Rs 1,700 may look small for now, but that's how, over time, his savings kept growing while his lifestyle did not actually feel restricted.

Now, Karan followed this rule as a monthly habit and continued to apply it, cutting just a little waste. Eventually, after 15 months, Karan was able to reduce his variable spending by up to Rs 2,000 per month, and each year he added a portion of that savings to his SIPs.

Let’s do some calculations to understand how big a difference such small additions to SIP investments make over the long term.

Suppose Karan invests Rs 6,000 monthly in a mutual fund for 10 years. At a 12 per cent rate of returns, he would have built a corpus of Rs 13.44 lakh.

An SIP of Rs 8,000 per month at 12 per cent returns for 10 years would build  a corpus of Rs 17.92 lakh.

If we further increase the SIP amount to Rs 10,000 per month, the corpus would grow to Rs 22.40 lakh.

Now, if we double the tenure to 20 years, at 12 per cent returns:

SIP of Rs 6,000 p.m. would build a corpus of Rs 55.19 lakh,

SIP of Rs 8,000 p.m. would make you Rs 73.58 lakh

And an SIP of Rs 10,000 p.m — Rs 91.98 lakh.

So, hope these numbers explain well how small steps can make big differences.

Apart from financial ease, now Karan knows every month where his money flows and how he is supposed to utilise his annual salary hike. He prioritises savings over increasing his expenses.

The best part is that these rules are not only for those willing to get out of a financial mess, but they are also useful for anyone who aims to grow their finances. These two rules are not just a numbers game; it is basically a mindset shift.