If you are looking for a budgeting method that helps track every dollar of your monthly spending, then the zero-based budget might be perfect for you. Before you get too excited, the zero-based budget doesn’t mean spending every dollar you make. Instead, the zero-based budget encourages you to assign responsibility for every dollar of your after-tax monthly income. Let’s look at exactly what a zero-based budget entails.
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What is Zero-Based Budgeting?
Zero-based budgeting is a budgeting strategy that forces you to assign a job for each dollar of your monthly income. At the end of the month, your income minus your expenses should be zero.
In zero-based budgeting, not all your “expenses” are for actual expenses, some money is allocated to meeting financial goals like paying off your credit card bill or saving for an emergency fund.
Zero-based budgeting is different from the pay-yourself-first budget because it wants you to have no money left at the end of the month. Zero-based budgeting prioritizes allocating every dollar versus emphasizing saving (although the two strategies can be combined).
Is living paycheck to paycheck the same thing as zero-based budgeting? No, because with zero-based budgeting you are still meeting your financial goals, like saving for a down payment, getting debt-free, or investing in stocks.
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Example of Zero-Based Budgeting
In this example, we used a monthly income of $5,000. All household essentials – rent, utilities, groceries – are assigned a dollar amount. It is important to note that once essentials are budgeted for you can move on to your personal and fun spending (finally) and savings goals. Need to pad your emergency fund? Put it in your budget. Buy your first home? Allocate funds to this saving goal. Need a vacation? You deserve it, so save for it.
A wonderful feature of the zero-based budget is that you can achieve a variety of spending and savings goals each month. This will compound over time and lead you to increase your net worth and meet your long-term financial goals.
How Zero-Based Budgeting Works
Implementing the zero-based budgeting system is relatively easy. Here are 6 steps to follow to begin the process today:
Step 1: List Your Monthly Income
The first step in the zero-based budgeting process is to list all your sources of monthly income. You can do this the modern way with a spreadsheet or budgeting application, or simply get out a pencil and paper.
What income should you include? All your income, including income from:
- Regular Paycheck
- Freelance Work
- Side Business
- Passive Income
- Interest Income
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Step 2: List Your Monthly Expenses
With an idea of how much income you must work with every month, now it is time to figure out how much money you need to spend. One of the easiest ways to do this is to bucket your money into categories of spending.
Below are three general categories used in the 50/30/20 budgeting system. You can use them too.
Necessities
- Rent/Mortgage
- Utilities
- Groceries
- Insurance
Saving & Investing
- Emergency Fund
- Slush Fund
- Retirement
- Extra Cash
Personal Spending
- Travel
- Going Out
- New Clothes
- Fun Money
There are two main types of costs to focus on. Your fixed costs are costs that do not change with your level of consumption (e.g., Rent), and variable costs that fluctuate based on how much of something you buy (e.g., Travel Costs). The fastest way to cut costs from your monthly budget is to focus on trimming your variable costs. But eroding your fixed costs will give you the biggest bang for your buck.
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Step 3: Subtract Your Monthly Expense from Income
Now that you know what is coming in each month and what is going out, it’s time to subtract your expenses from your income. With zero-based budgeting, it should be zero.
You might not have a zero the first time, but that is okay. If you have a number greater than zero that simply means you need to assign money to a new expense or give an existing expense more money. Now, if you have a negative number that means you need to reduce your spending somewhere. You are spending more than you make; that is not a place you want to be financially. Keep in mind, that it might take a couple of cycles for your zero-based budget to reach zero.
Step 4: Monitor Your Progress
Once your income minus your expenses reaches zeros, you can start using your budget. After you have set your monthly budget, it is important to monitor how well you are sticking to your budget. Did you spend your money according to the categories you envisioned? Did you overspend in one area and underspend in others?
Take the time to truly assess your performance. As a budgeting newbie, it might take several months before you can hit your expense categories perfectly. Once you do, it will be time to create another budget for next month.
Step 5: Create a New Monthly Budget
The budgeting process is continuous. Once a new monthly budget ends, a new monthly budget begins. This might sound like a lot of work. Trust us, it’s not. If a monthly budget grows stale after reaching your financial goal, like saving for an emergency fund, you can move on to your next goal. After you have created your first zero-based budget, all you must do is recalibrate where money is going to reach your next financial milestone. You can do it efficiently by automating your finances.
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Creating an automated financial ecosystem, no matter what budgeting system you are using (except for the cash envelope method), will help you reach your goals quickly and effectively.
Step 6: Decide If Zero-Based Budgeting Is for You
Not all budgeting systems will be right for everyone. The goal is to choose a budgeting system that feels right to you. The zero-based budget might be too time-consuming or advanced for your personal financial needs. If you only want to focus on reaching savings goals, then another budgeting system like the pay-yourself-first budget might be a better fit.
As your financial goals evolve, so too will your budget. You can scale up and down on your budgeting needs depending on your immediate financial goals. In the end, budgeting is all about inserting financial control into your money life.
Advantages of Zero-Based Budgeting
Easy to Understand: The zero-based budget is a conceptually easy-to-understand budgeting system. Once you stick to this budgeting system for a couple of months, you will absorb how this works. By assigning every dollar a job, you will know where your month is going.
Automation: The ability to automate your finances will set you up for success month after month. With small wins along the way, like meeting small saving goals, you can start to see the effects of automation compound. For example, saving $300 per month will suddenly turn into $3,600 at the end of the year.
Change Allocations: Depending on whether you are using the 50/30/20 budget for spending allocations or another method, you can tweak your allocations. The 50/20/30 budget wants you to follow the following percentages: 50% to your monthly needs, 20% to saving and investing, and 30% to personal spending. Of course, this doesn’t consider your financial situation. If you have a lot of student loans to pay off, you will want to increase your debt payments. However, if you are debt-free and trying to save aggressively for retirement, you will want to boost your savings above 20%. You can change your allocation easily with the zero-based budget.
Disadvantages of Zero-Based Budgeting
- Unpredictable Income: If you are a freelancer or hourly worker with an irregular or unpredictable roster of projects and clients, then implementing a zero-based budget might be more difficult. Knowing how much income you have is a critical part of implementing this system. A workaround is to save 1-3 months’ worth of income in your slush fund and then create a zero-based budget, knowing that in low-income months you may have to dip into your slush fund.
- Hard to Implement: The initial barrier to entry for the zero-based budgeting system is allocating all your expenses. Other systems like the pay-yourself-first method don’t take as much work upfront and focus on one goal: savings. With zero-based budgeting, you will need to map out your income, expenses, and financial goals.
Popular Budgeting Methods
Don’t think the zero-based budget will work for you? That’s okay. There are plenty of highly effective budgeting strategies helping millions of people reach their financial goals. Below are some of our favorite budgeting systems:
What is the Best Budgeting Method?
Here’s the deal. There is no magic pill when it comes to budgeting, you will need to find a system that works for you. At Smart Money, we don’t simply recommend one budgeting system over the rest. Instead, we want you to explore and find the right budgeting system that works with your financial goals and lifestyle.
The zero-based budget could be exactly what you need. However, if you are at a point where you are prioritizing saving for an emergency fund, down payment, or investing the pay-yourself-first could be a better fit. On the other hand, if you need help tightly managing your money, consider the envelope budgeting system.
Conduct due diligence on the different budgeting systems and experiment with spending allocations. You will eventually find a perfect budgeting solution to your financial goals.
Smart Summary
Listen: Picking a budgeting system doesn’t have to be difficult. But if you want to make progress on your money goals, then you do need to create a monthly budget. The process of budgeting flips the power of money into your hands. Instead of wondering where your money is going, you are not telling your money where to go. That is a game changer.
If you want supreme control over your finances, then a zero-based budget will give you exactly the control you are looking for. You are telling every dollar where to go. Make your money work for you with the zero-based budgeting system, it’s a smart money move.
Frequently Asked Questions
In a word: zero. After subtracting your expenses from your income, you should have no money left to allocate. This doesn’t mean that you are spending all your income, it simply means that you have allocated your money to all its necessary categories.
The zero-based budget doesn’t recommend specific savings guidelines like the 50/30/20 budgeting system. Personal finance experts suggest saving between 10-30% of your after-tax income, depending on your immediate financial goals. If you need to pay off debt, then you should lower how much you are saving to become debt-free.
This isn’t the 1980s, you don’t have to use a pencil and paper anymore to create an effective budget (although that still works). Today, some awesome budgeting applications can help you track, manage, and hold you accountable for your budgeting process. Here are Smart Money’s recommendations for the best budgeting applications.
Yes, in a sense. By implementing a budget, you are telling every single dollar where to go. This injects financial control into your life. Financial control will allow you to tackle important financial goals like paying off credit cards, saving for an emergency fund, or start investing. All these actions will increase your net worth.
For you? Yes! Here is our free budget planning worksheet. Our worksheet will help you get your income and expense in order. Then you can decide what budgeting strategy works best for your financial situation.
