Categories

Budgeting & Saving

How Does Zero-Based Budgeting Work?

Zero-based budgeting is a method of managing your money so that every dollar is accounted for, and your expenses (including savings) equal your income each month.

This type of budgeting is more labor-intensive than other budgeting approaches, but it can provide a deeper understanding of where your money is going and how you can better manage it.

How Zero-Based Budgeting Works

The idea behind zero-based budgeting is that when you subtract your expenses from your income for a given month, the difference is zero. You achieve this balance by essentially assigning a job to every dollar you earn. Here's an example of how one month's zero-based budget might look:

IncomeAmount
Wages (take-home pay)$4,000
Side business$500
Total income$4,500
ExpensesAmount
Rent$1,200
Debt payments$750
Savings$500
Groceries$450
Utilities$300
Medical$250
Dining out$200
Insurance$200
Clothing$150
Entertainment$100
Household items$100
Miscellaneous$300
Total expenses$4,500


As you can see, what's left over at the end of the month is categorized as savings and is included as a budget item. Because you've budgeted every dollar for the month, if you go over in one category, you'll need to take from another category to avoid having your expenses exceed your income.

Zero-based budgeting is best for people who can reasonably assume what their income and expenses are going to be every month. If you own a business or have irregular wages, it can be tough to estimate a budget.

How Is It Different From Traditional Budgeting?

The idea of a traditional budget is to make sure your expenses are less than your income. With zero-based budgeting, however, your objective is to make them equal.

Also, a zero-based budget will usually have many more categories than a traditional budget. If you're accounting for each dollar you spend, you'll likely need to more specifically break down your categories. With a traditional budget, you may choose to combine certain categories for the sake of simplicity.

For example, a traditional budget may break your spending down into fixed expenses and variable expenses, or maybe you split up your budget by necessities, financial goals and discretionary spending.

A zero-based budget requires a lot more time and effort to keep track of where your money is going, and it leaves less room for error. And while that might not be appealing to some, it will make it easier to know where to cut back if you want to start saving more or paying down debt.

When Does it Make Sense to Use Zero-Based Budgeting?

Because a zero-based budgeting approach requires more time and attention, it's best suited for experienced budgeters. If you're just starting out, it can be easy to get overwhelmed by the process and the restrictions, which can be discouraging.

Zero-based budgeting works well for someone who has at least a small emergency fund to fall back on if spending surpasses a set budget for one month. It's easy for an expense to slip your mind during the planning process, so having a buffer can help if you forget a bill or get hit with a surprise charge.

Finally, a zero-based budget requires that you have the time and energy to plan and track your expenses. If you're busy or generally don't want to spend more time on your budget than you have to, it might not be a good fit.

Alternative Ways to Budget

While zero-based budgeting can be an excellent way to manage your money, it's one of many methods you can use. Here are just a few alternatives:

  • 50/30/20 budget: With this approach, 50% of your money goes toward necessities, 30% toward discretionary spending (your lifestyle), and 20% toward your debt and savings. You can play with the ratio to better fit your situation—for example, maybe you'd prefer to put 30% of your income toward savings and debt and 20% toward your lifestyle—but the idea is the same.
  • Two-account budget: With this method, you have two checking accounts and automatically split your paychecks between the two. Use the first account to pay your monthly bills like rent, utilities and debt, and use the cash in the second one however you want. As long as your account balances are above zero, you don't have to worry about keeping track of every dollar.
  • Envelope system: This approach is similar to zero-based budgeting. You decide how much you're going to spend in each category, then withdraw enough cash for your budget period. You'll then divvy up the money into envelopes, one for each spending category. Whatever you budget, that's what you have for the month—if you go over in one area, you take from another envelope.

There are many ways you can budget your money, and no one method is best for everyone. So take some time to consider your budgeting goals and preferences, then pick the approach that most appeals to you.

Keep Your Goals in Mind

The zero-based budgeting method is a great way to achieve your financial goals. This type of budget gives you an in-depth look at where your every dollar is going—something you won't necessarily get from other budgeting approaches.

But if you're not in a position to spend much time managing your money or the idea of it is too overwhelming, having some kind of budget is better than not having one at all. So if you get started on zero-based budgeting and decide it's not for you, consider an alternative before you give up on budgeting altogether.

The goal with any budget is to help you better manage your money, and there's not a lot you can lose with that goal in mind.

Resources