DEFINITION
Zero-based budgeting is a budgeting strategy where you allocate every dollar of income. By the end of the month, after calculating all your expenses, savings, and expenses, you should have very little left.
Key Takeaways
- Zero-based budgeting is when your income minus expenses is zero, leaving you with no money to spend at the end of the month.
- It allocates every dollar you make to a specific job.
- With a zero budget, you know exactly where your money is going and can prioritize your personal financial goals.
Zero-based budgeting definition and examples
A zero-sum budget, also known as a zero-sum budget, is where your income minus your expenses is zero. It encourages you to use the money you receive every month to spend, pay down debt, and achieve financial goals. With this strategy, you’ll know exactly where all your money is being spent each month.
For example, let’s say you take home $3,000 per month. With a zero-based budget, you spend all your money on bills, savings, and expenses, leaving you with a balance of $0 at the end of the month.
Alternative name: Zero-sum budgeting
This is how zero-based budgeting works
First, you need to know how much your take-home pay is each month. Next, you need to know what your total monthly expenses are. You then have to use every penny you have to pay for those expenses, including the money you want to save and the money you want to spend on activities like shopping or eating out.
For example, let’s say you take home $5,000 a month from your job. Of that, you can use $2,000 to pay for living expenses like rent, utilities, and groceries, and then use $1,000 to pay down student loans and credit card debt.
You then set aside $1,500 in savings to build an emergency fund and one day buy a home. The last $500 will go toward eating out, shopping, gas, travel, or anything else you want and can afford.
Starting monthly budget | $5,000 |
Living expenses | $2,000 |
Student loans and credit card debt | $1,000 |
Savings | $1,500 |
Wants (shopping, dining out, travel, etc.) | $500 |
Ending monthly budget | $0 |
In this case, your income of $5,000 minus all expenses of $5,000 is $0.
With a zero-based budget, if you’re underspending in one category, consider allocating the unspent money to another category. Conversely, if you overspend in one category, you have to raise money from another category to make up for it.
Pros and Cons of Zero-Based Budgeting
Pros
- Offers visibility
- Prevents overspending
- Prioritizes financial goals
Cons
- Time-consuming to create
- May be difficult with unpredictable income
- Doesn’t always account for variable expenses
Pros Explained
- Offers visibility: Zero-based budgeting makes it easy to see where your money is going each month. If you implement this strategy, you will clearly see that you are spending X on expenses, X on debt, X on savings, and X on the things you want.
- Prevents overspending: If you tend to overspend, zero-based budgeting can help. You may be less likely to spend money you don’t have because it’s already spent on another part of your budget.
- Prioritizes financial goals: You can create a zero budget to achieve your personal financial goals. For example, if you want to pay off your student loans as quickly as possible, you could dedicate a large portion of your money each month to paying down that debt.
Cons Explained
- Time-consuming to create: Creating a zero-based budget can take some time. You’ll need to calculate your monthly take-home pay, decide how to spend it, and earmark each dollar for a specific category.
- May be difficult with unpredictable income: If you’re self-employed, freelance, self-employed, or work on commission, your income may fluctuate from month to month. This can make it a little difficult to create and stick to a zero-based budget because your income is inconsistent. If you’re lucky, you might be able to use last month’s income to determine how much you need to contribute this month.
- Doesn’t always account for variable expenses: Irregular or unexpected expenses will inevitably crop up every month. Unless you have specific categories, zero-based budgeting may not help you bill or prepare for it.
Notes
You can create a special category for irregular expenses, which can help pay for things like car maintenance, vet bills, gas, or gifts.
How to Create Your Own Zero-Based Budget
If you want to create your own zero-based budget, follow these steps:
Determine Your Net Income
Add the amount of your salary to all other sources of monthly income. Here you’ll find out how much you need to spend each month.
Notes
You calculate your take-home pay, which is what you earn after tax and pension contributions. This is also called your net income.
Track Your Spending
Use several months of credit card statements and receipts to track your daily spending. This will help you discover categories where you can reduce your spending and areas where you want to increase your spending.
Categorize Your Expenses
Write down your expenses and priorities. Add everything you need and want. Your needs might be things like rent, utilities, and health insurance, while your wants might be gym memberships, takeout food, and entertainment. If you want to save money to buy a home, create a “Housing Finance” category. Do you want to pay off your credit card debt? Create a “Credit Card Debt” category.
Notes
You can create and track a zero-based budget using a budgeting app like Mint or You Need a Budget (YNAB), a spreadsheet, or a notebook.
Alternatives to Zero-Based Budgeting
If you’re not sure whether zero-based budgeting is right for you, consider these alternative budgets:
- Cash only: As the name suggests, you can only pay for your wants and needs with cash. That means no debit or credit cards, no payment apps like Venmo, and no checks.
- Envelope method: Similar to cash-only budgeting and zero budgeting, you use envelopes to allocate funds to different categories. Once the envelope is empty, your spending for the month is over.
- 50/30/20: Under this budget, you spend 50% of your net income on your wants, 30% on your needs, and 20% on savings or financial goals. 1
- 80/20: Similar to the 50/30/20 budget, this budget allocates 20% of your budget to saving and 80% to spend.
SOURCESTiny Tips uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles.
- Consumer Financial Protection Bureau. “Analyzing Budgets.” Accessed May 27, 2021.