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Zero-Based Budgeting 101

Budgeting

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. Read on to find out if this strategy is right for you.

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, or some other goal. If productivity, efficiency, and structure are important to you, then this system might be just what you’re looking for.

Money coach Nick True of Mapped Out Money and his wife Hanna have been using a zero-based budget for seven years. Using this budget has forced them to spend their money in a way that more closely reflects their goals.

“A zero-based budget has helped us be efficient with our money and consciously spend it in a way that aligns with our values,” he said.

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:

  • Housing
  • Transportation
  • Debt including student loans, credit cards, and personal loans
  • Savings
  • Groceries
  • Utilities and internet
  • Health insurance and medical expenses
  • Childcare
  • Entertainment
  • Subscriptions and memberships
  • Personal care
  • Pets
  • Gifts and charity

Then, decide how much you want to allocate for each specific category. 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.

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.

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.

“For example, I recently had to take my cat to the vet, and the bill was more than I currently had sitting in my pets category,” True said. “So I moved money from clothing and dining out over to the pets category to cover it for the month.”

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.

Other Budgeting Systems

If a zero-based budget sounds too confusing or difficult to set up, here are some simpler alternatives:

50/30/20 Budget

The 50/30/20 budgeting method, developed by Senator Elizabeth Warren, is a simple budgeting system that works well for beginners.

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. It’s a good choice for someone who wants to budget regularly but finds zero-based budgeting too involved or too restrictive.

Cash Envelope

The cash envelope system involves using physical cash to pay for all eligible expenses. 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.

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.

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