You got your paycheck, a few weeks go by, and you can’t seem to figure out why you’ve run out of money to cover a bill or two. Does that ring a bell?
Don’t feel guilty! Managing or controlling where your money goes is no easy job for anyone (so don’t worry, you’re not alone on this one). This is where zero-based budgeting comes into play to save the day.
You might be thinking: “So, what is it?”, “How does it work?” or “How do I make one of my own?” Hold your horses because we’ve got you covered.
In this post, we’ll be going over every fundamental you need to know about a zero-based budget, how it works, how to create one, and its pros and cons. Once you’re all set, let’s begin, shall we?
What is it zero-based budgeting?
In a nutshell, zero-based budgeting is a method that comprises your monthly earned income minus expenses. Now, for every dollar you make, they will be allocated to expenses that include your needs, wants, or savings. At the end of every month, your earned income minus your expenses should always be equal to zero.
As you can see, there are no fancy or sophisticated formulas behind this. Just a simple yet effective financial framework you can leverage for better financial health in the long run.
Since zero-based budgeting is not about how to allocate your money, but a method is which every dollar is accounted for, you would need to use it in conjunction with some sort of allocation budgeting method. More on that below!
What makes a budget a zero-based budget?
So, what makes zero-based budgeting different from the traditional budgeting method anyway? Well, here you go.
- Zero-based budgeting requires you to set up the budget from scratch as you allocate and re-allocate your monthly earnings to your expenses. Whereas traditional budgeting takes the previous year’s budget as the foundation of the budget setup.
- Traditional budgeting is mainly based on the previous expense levels. In contrast, zero-based budgeting is based on which expense categories you need to prioritize based on your personal financial goals.
- Zero-based budgeting enables you to clearly identify and assess which expense categories you tend to overspend on, so you can easily make changes accordingly by monthly re-allocations. In contrast, traditional budgeting is less capable of that sort of flexibility.
As the name implies, it essentially ensures every dollar you earn as income is assigned to different expense categories until the difference between your income and overall expenses equals zero.
These expenses categories include your needs (e.g., rent, groceries, insurance, etc.), savings (e.g., emergency funds, debt repayments, and investments), and of course, your beloved wants. If everything is precisely according to budget, then kudos to you!
But, if an expense category at the end month falls short of the budget, you may want to add any excess or remaining amount to that category.
This particularly comes in handy if you tend to overspend.
You can then re-strategize and have the budget direct you in re-prioritizing particular expense categories (e.g., health insurance instead of a dine-out at a fancy Italian resto, or paying off some debt instead of buying a piece of new furniture).
Doing so enables you to make wiser financial decisions from there on out. Though this budgeting type takes some time and effort, trust us, this simple framework can go a long way to help you to be financially well off!
If this is your first rodeo in making or using a zero-based budget (which would obviously be the reason you’re reading this), follow these simple steps, and you should have a financial blueprint up and ready to go.
1. Know your monthly earnings.
This essentially includes all the money that goes into your pocket (by pocket, we mean your bank account). This includes anything from your job paycheck, benefits, side hustles, or any other type of income source that adds those extra dollars you get in a month.
This is a vital step to help you know how much you can utilize for your budget.
2. Keep track of all expenditures for a few months (~ 3 to 4 months)
If you are already aware of your regular expenses (such as utility bills, groceries, and transportation fees), give yourself a pat on the back! However, if you don’t think you’re quite there yet, then don’t worry. It’s never too late to start paying attention to where those cha-chings go.
Once you’ve identified your typical expenses, this helps you pinpoint areas of concern such as a need to allocate more money into emergency funds or debt repayments, and less on specific wants such as watching movies in the cinema (streaming or YouTube will do for the moment).
We recommend using a spreadsheet such as Excel to take note of these expenses in an organized manner. You can even use graphs or charts to visualize and assess what your expenses look like in a glimpse.
3. Create categories for these listed expenses
Once you have all things you’ve spent money on in a regular month jotted down, it’s time you assign them to categories! These include your needs, wants, and savings. Here is a list of examples that may fall under each of those categories:
- Utilities (water and electricity bills)
- Insurance (Health, dental, homeowner’s insurance, life insurance, disability insurance)
- Personal (personal caring needs and lifestyles such as clothing and gym memberships)
- Miscellaneous (this essentially serves as an “overflow” to cover over-budget expenses)
- Entertainment (subscriptions to Disney+ and your hobbies)
- Travel fund
- Emergency funds (for 6 months, at least)
- Retirement fund (401k or a Roth IRA)
- Debt repayments
- Investments (stocks, bonds, crypto, NFTs, cash, etc.)
If you need help identifying between needs and wants, check out this handy guide.
4. Allocate your earnings to these categories
So how much would you typically allocate to each of these categories? An old-time yet timeless method would be the 50/30/20 method. 50 percent goes to needs, 30 percent to wants, and 20 percent to savings. These are default percentage allocations, which means you can alter them as you please, so it could also be a 70/20/10, for example, which is another great method of budgeting.
Congrats! You just made your very own zero-based budget from scratch!
Zero-based budget example
Total income: $3500 – all expenses below add up to exactly $3500
|Credit card payments||$400|
Zero-based budgeting apps
There are a couple of zero-based budgeting apps for the technically inclined. They help to keep things organized and looking sweet, and are great for those of you who are always on-the-go.
A couple of our favorites are the EveryDollar app by Dave Ramsey and the YNAB app by Jesse Mecham.
We like the YNAB app a little more just because once you get the hang of the app, it leaves very little room for mistakes. It makes it very easy to look at everything at a glance.
Check out our full review of the YNAB app.
Like a coin, there are always two sides to everything, even in budgeting methods! With that being said, here are some of the ups and downs of zero-based budgeting.
The pros of a zero-based budget
The zero-based budget is a great tool to help you monitor how much you earn and spend. That way, you won’t bite off more than you can chew (aka go over the budget and overspend).
In addition, it enables you to assess your monthly spending, your spending habits, and how well you manage your money from an overall standpoint. You can then reallocate funds to specific expense categories that may be lacking or having excess funds.
It is also known as an excellent budgeting method for beginners in financial management and for those who earn on a regular basis (e.g., any 9-5 job with salaries)
The cons of a zero-based budget
A significant downside to this budgeting method is the time it takes to set it up on a monthly basis. Zero-based budgets require full accountability and thorough expense-tracking on where each dollar you pull out goes to.
Another is the fact that it has quite a number of variable expenses that may fluctuate from time to time. Variable expenses may include car fuel, purchasing that 20% off pair of boots for the fall, groceries, utility bills (e.g., electricity bills are usually higher in colder months), or taking your pet to the vet for healthcare.
There is a way to get on top of this, and that is by setting up a savings fund or a miscellaneous fund to anticipate and cover any fluctuating amounts throughout the different expense categories.
It may not be the best budgeting method for those who earn irregular income, such as freelance writing or reselling sneakers online, to name a few.
You can still go down this road as long as you have a month’s worth of income saved up to serve as a starting cushion. Then use that income as this month’s budget.
The Bottom Line
By now, we all know just how crucial financial management and planning truly are, especially after the pandemic that shook the world to its core.
Although we are by no means capable of predicting the future (as much as we would very much like to be), we are capable of preparing by planning ahead to expect the unexpected the future holds.
A great way you can do this is by using the zero-based budgeting method. You take your monthly earnings and subtract them by the sum amount of all your expenses categories (needs, wants, and savings) until it equals zero.
Though this method requires you to be held accountable, thorough, and patient (as it does take a while to set up), it could definitely prove itself valuable. This budget works fantastic if this is your first time planning your finances and/or for those who are regular income earners.
To sum it up, here’s a gift quote from a proverb that goes: “The art is not making money, but in keeping it.”
And to that, we say touché and cheers!