Putting your money to work is one of the best ways to maximize your financial potential. Whether you make six figures a year or minimum wage, every dollar you bring in is an opportunity to make more.
But strategically allocating your finances is about more than just funneling money into your investment accounts. It’s also the best way to plan and save for the things that are most important to you, like a vacation to Bali or a down payment on a new home. Zero-based budgeting is one of the most popular ways to do this.
In this series, we’ve already gone over several important topics about budgeting, like what a budget is, what to include in your budget, and how you can create a budget with Mint. We’ve also discussed various other ways on how to create a budget, like with a free budget template or with the 50/30/20 budget rule.
In this chapter, we’ll be discussing the zero-based budget definition, how you can create a zero balance budget, the pros and cons of this method, what to include in your budget, and more. Read on to find out if this strategy is right for you, or use the links below to navigate the article.
What is Zero-Based Budgeting?
Zero-based budgeting, also known as zero-sum budgeting, centers around the principle that every dollar in your budget should be categorized. At the end of the month, a zero-based budgeting system lets you know where 100% of your income went.
The difference between a regular budget and a zero-based budget is that a traditional budget allows leftover money to sit in your checking account.
A zero-based budget would require that you move those extra funds to savings, debt payoff, investments, or some other goals. You can use an investment calculator to figure out exactly how much you can realistically put towards investments based on your income.
productivity, efficiency, and structure are important to you, then this system might be just what you’re looking for.
How Does a Zero-Based Budget Work?
assign all of your income to specific categories until there’s no money left over. Essentially, with a zero-based budget, you want your income minus your expenditures to equal zero at the end of every month.
How to Create a Zero-Based Budget
Start by making a list of all the categories where you spend money every month. These may include:
- Debt including student loans, credit cards, and personal loans
- Utilities and internet
- Health insurance and medical expenses
- Subscriptions and memberships
- Personal care
- Gifts and charity
In addition to creating categories for your living expenses, you’ll also need to create categories for your financial goals, whether that be for savings or paying off debt. If you need to budget for travel or save up for a new car, those should also be categories.
Then, decide how much you want to allocate for each specific category by looking at how much you currently have in your checking account. You can use your monthly credit card and bank statements to estimate a realistic figure.
One feature of zero-based budgeting is that you use last month’s income to determine how much you can spend. This way, you’re only using money that’s already in your bank account and not relying on a future paycheck. That’s why zero-based budgeting is particularly helpful for consumers with a variable income.
Once you’ve written everything out, subtract the expenses from the income. On conditions that your expenses exceed your income, you’ll have to revise the budget to cut costs or readjust your financial plan to make more money. You can try out a more minimalist lifestyle to cut back on some of your expenses or you can increase your income with a high-paying job. It’s important to work towards your ideal salary so that you can have more income to save and spend.
If you have money left over, you need to assign it to a category. If you don’t, you’re more likely to spend it on something non-essential, instead of putting it toward a long-term goal. This is the essence of zero-based budgeting.
You’ll most likely need to readjust your zero based budget, as you may come across unexpected expenses from time to time. But that is okay! Just edit and tweak your zero budget as needed.
Example of a Zero-Based Budget
If you’re confused by the concept of zero-based budget, don’t panic just yet. We understand that this way of budgeting can be confusing, which is why we’re sharing an example of how this method is applied to real-life expenses to provide some clarity.
Say you earn $3,000 a month after taxes. Your zero-based budget will look something like this:
- Rent: $1,000
- Utilities: $150
- Food: $200
- Cell phone: $50
- Transportation: $200
- Subscriptions: $100
- Medical expenses: $100
- Fun money: $150
- Vacation: $100
- Pets: $50
- Car insurance: $100
- Student loans: $200
- Savings: $400
- Additional debt payments: $200
Once you add all of these up and subtract them from your total income, you’re left with $0. That is the goal of a zero-based budget.
This budget already includes categories for savings, debt payments, and additional expenses (like fun money), so you know exactly where all of your money is going each month. You can even challenge yourself to save more by gradually increasing the amount of money you add to your savings category.
A zero-based budget can be a great way to start budgeting if you’re relocating to a nice city for a job. To get started with a zero-based budget, it may be helpful to figure out your cost of living so that you can anticipate how much you’re going to spend in that area. You should also calculate your rent budget based on your income so that you don’t overspend on rent.
How to Implement a Zero-Based Budget
After you’ve created a budget, you have to start tracking and categorizing your expenses. It’s best to do this every day, or at least once a week because it can get overwhelming if you wait any longer. Find a routine and schedule that’s easy for you to stick to.
If you keep overspending in a certain category, stop and consider if you need to increase the amount in that category – or find ways to remove the temptation.
You should also remember that a zero-based budget is not static and that you should change the budget when necessary. If Christmas is coming up, for instance, you may want to allocate more money in the gifts category.
How Does it Compare to Other Budgeting Methods?
A zero-based budgeting system may require more maintenance and diligence than other types of budgets. Because you have to give each dollar a job, that means you also have to track each dollar that you spend. This can be time-consuming and frustrating.
If you have an unexpected expense in a zero-based budget, you’ll have to revise your budget or use your savings.
Because you have to classify each transaction, zero-based budgeting forces you to confront how much you actually spend. If you keep overspending on take-out or random Amazon purchases, your budget will tell you. You can’t hide your spending habits from a zero-based budgeting system.
Pros of Zero-Based Budgeting
- It tells you exactly how much you’re spending: If you want to become more aware of how you’re spending your money, using a zero-based budget is a great way to do so. It makes it obvious where you need to cut back on expenses and how you can do so, like with a grocery budget.
- It’s very flexible: It’s unlikely that your expenses will stay the same every single month. You’ll most likely need to make adjustments on a regular basis. While it might be frustrating to make changes, the 0 based budget is flexible. With a zero-based budget, you’re tracking your spending in real time so you can easily make adjustments as needed.
- Prevents you from spending more than what you’re making: The last thing you want to happen is to find yourself in a budget deficit. But with zero-based budgeting, that’ll be hard to do. Since you allocate all your income to specific categories, this helps to prevent you from spending beyond your means.
Cons of Zero-Based Budgeting
- It’s tedious: One of the major cons of a zero-based budget is that it can be very time-consuming. You have to constantly monitor and track your spending, and inputting all of your expenses on a monthly basis can be quite tedious.
- Doesn’t work great with variable expenses: It’s more than likely that you’ll find yourself spending money on expenses that you didn’t anticipate from time to time. These are called variable expenses, and a zero-based budget doesn’t always account for them.
Weighing the pros and cons of the various budgeting methods can help you narrow down which system works best for you and is most likely to keep you motivated to stick to your goals.
Other Budgeting Systems
If a zero-based budget sounds too confusing or difficult to set up, here are some simpler alternatives:
The 50/30/20 budgeting method, developed by Senator Elizabeth Warren, is a simple budgeting system that works well for beginners.
How does the 50/30/20 budgeting method work?
The method involves dividing your monthly income into three categories: 50% toward needs, 30% toward wants, and 20% toward saving/debt payoff. When you make a transaction, you’ll classify the item as a need, want or saving/debt payoff.
The 50/30/20 system is easy to use because there are so few categories, leaving room for personalization and improvisation.
Who should consider the 50/30/20 budgeting method?
It’s a good choice for someone who wants to budget regularly but finds zero-based budgeting too involved or too restrictive.
The cash envelope system involves using physical cash to pay for all eligible expenses.
How does the envelope budgeting method work?
You decide how much to spend and withdraw the cash from your bank account, then you divide it into envelopes labeled with the category name.
For example, if you’ve allotted $500 to groceries, you would withdraw $500 in cash and put it in an envelope marked “groceries.” That $500 is supposed to last you the rest of the month. If you spend it before the month is over and still need groceries, you’ll have to take money from other categories, dip into your savings or find a way to earn more money.
Who should consider the envelope budgeting method?
This system is great for people who prefer a more analog approach, or for anyone who needs a little extra help to avoid overspending on certain categories.
Zero-Based Budgeting Can Help You Organize Your Finances
The goal of zero-based budgeting is to have an organized, efficient structure to how you spend your money. Each month, you know exactly where your money is going, so you don’t have to worry about spending it on unnecessary expenditures or spending more than you’re making.
Zero-based budgeting can help you organize your finances so you can stay on track with your financial goals.
With another budgeting system under your belt, you can move on to the next chapter in the series which covers how to manage your budget.
Chapter 07: Using the 50-30-20 Rule to Budget