Definition and Examples of Zero-Based Budgeting
Also known as zero-sum budgeting, zero-based budgeting is where your income minus your expenses equal zero. It encourages you to dedicate the money that flows in every month toward expenses, debt payoff, and financial goals. With this strategy, you’ll know exactly where all your money goes on a monthly basis.
For example, let’s say you take home $3,000 per month. With a zero-based budget, you’d allocate all of that money to bills, savings, and spending, so that at the end of the month you have $0 left.
- Alternate name: Zero-sum budgeting
How a Zero-Based Budget Works
First, you need to know how much you earn in take-home pay every month. Next, you need to know what your total monthly expenses are. Then, you need to allocate every dollar and penny to paying those expenses, including any money you want to save as well as any money you want to spend on activities like shopping or dining out.
For example, let’s say you take home $5,000 per month from your job. You may put $2,000 of that toward living expenses like rent, utilities, and groceries and then $1,000 toward your student loans and credit card debt.
You then allocate $1,500 to savings so you can build your emergency fund and buy a house some day. The last $500 goes toward eating out, shopping, gas, travel, or anything else you may want and can afford.
|Starting monthly budget||$5,000|
|Student loans and credit card debt||$1,000|
|Wants (shopping, dining out, travel, etc.)||$500|
|Ending monthly budget||$0|
In this scenario, your income of $5,000 minus all of your expenses of $5,000 equals $0.
With a zero-based budget, if you underspend in one category, you should reallocate that unspent money to another category. On the contrary, if you overspend in one category, you’ll have to find money from another category to make up for it.
Pros and Cons of Zero-Based Budgeting
Prioritizes financial goals
Time-consuming to create
May be difficult with unpredictable income
Doesn’t always account for variable expenses
- Offers visibility: A zero-based budget makes it easy to see exactly where your money goes every month. If you implement this strategy, you’ll clearly see that you spent X on expenses, X on debt, X on savings, and X on your wants.
- Prevents overspending: If you tend to overspend, a zero-based budget may help. You may be less likely to spend money you don’t have since it was already spent on another part of your budget.
- Prioritizes financial goals: You can create a zero-based budget to meet your unique financial goals. If you’d like to pay off your student loans as soon as possible, for example, you can allocate a good chunk of your money toward that debt each month.
- Time-consuming to create: It can take some time to create a zero-based budget. You’ll have to calculate your monthly take-home pay, decide how you’d like to spend it, and dedicate each dollar to a certain category.
- May be difficult with unpredictable income: If you’re self-employed, a freelancer or sole proprietor, or work on commission, your income likely fluctuates every month. This can make it a bit of a challenge to create and stick to a zero-based budget since your income is inconsistent. If you’re lucky, you may be able to use your previous month’s income to figure out how much you have to allocate this month.
- Doesn’t always account for variable expenses: Irregular or unexpected expenses are bound to pop up from month to month. Unless you have a specific category for them, a zero-based budget may not help you account or prepare for them.
You can create a specific category for irregular expenses that can help cover things like car maintenance, vet bills, gas, or gifts.
How to Create Your Own Zero-Based Budget
If you’d like to create your own zero-based budget, follow these steps:
Determine Your Net Income
Add the amount of your paycheck with any other sources of monthly income. This will tell you how much money you have to spend each month.
You’re calculating your take-home income, which is the money you make after taxes and retirement contributions are taken out. This is also known as your net income.
Track Your Spending
For a few months, use credit card statements and receipts to keep tabs on what you usually spend. By doing so, you’ll discover categories in which you can cut your spending as well as areas where you’d like to allocate more.
Categorize Your Expenses
Write down your expenses and priorities. Include everything you need and want. Your needs may be things like rent, utilities, and health insurance while your wants may be your gym membership, takeout food, and entertainment. If you’d like to save money to buy a house, create a “house fund” category. Want to pay down your credit card debt? Create a “credit card debt” category.
You can use budgeting apps like Mint or You Need a Budget (YNAB), a spreadsheet, or a notebook to create and track your zero-based budget.
Alternatives to Zero-Based Budgeting
If you’re not sure whether zero-based budgeting is fight for you, consider these alternative budgets:
- Cash-only: As the name implies, you can only use cash to pay for your needs and wants. That means no debit or credit cards, no payment apps like Venmo, and no checks.
- Envelope method: Similar to a cash-only budget and the zero-based budget, you’ll use envelopes to allocate money to different categories. Once the envelopes are empty, your spending for the month is done.
- 50/30/20: With this budget, you’ll allocate 50% of your take-home pay to needs, 30% to your wants, and 20% to savings or financial goals.
- 80/20: Similar to the 50/30/20 budget, this one allocates 20% of your budget to savings and 80% to spending.
- A zero-based budget is when your income minus your expenses equal zero so you have no money left to spend at the end of the month.
- It assigns every dollar that you earn to a specific job.
- With a zero-based budget, you’ll know exactly how you spend your money and be able to prioritize your particular financial goals.