A zero-based budget, also known as a zero-sum budget, assigns every dollar a job in achieving your financial goals. Originally created by business leaders for business budgets, this strategy has also found its way into household budgeting.
What is zero-based budgeting?
Zero-based budgeting directs every dollar you earn toward one of your expenses or financial goals. This gives every dollar a purpose, and at the end of each month, every dollar will have been spent or assigned to goals.
“Zero-based budgeting is where you account for every dollar before you spend it,” says Deacon Hayes, budgeting expert and personal finance author. “Instead of being reactive, you are proactive.”
This type of budgeting turns your savings goals into part of your budget and invests money in all your specific goals, such as entertainment or savings. Unlike a traditional budget, where some of that money would stay, every dollar in a zero-based budget is earmarked for a purpose.
“A lot of people, including (my wife and I) when we were in debt, felt like we were living paycheck to paycheck. You would come to the end of the month and say, ‘Where did it all go? money?” said Hayes. “With a zero-based budget, you say, ‘I want to save $100. I want to put an extra $200 on my credit cards.’ You have so much more control, and therefore more likely to be successful when it comes to managing your money.”
Zero-based budgeting can be especially useful for those who like to plan their spending.
How to Create a Zero-Based Budget
Creating a zero-based budget is similar to creating a regular budget. But, with a zero-based budget, every dollar will be spent on a goal and there will be nothing left. Here are the steps to create a zero-based budget:
- Gather your income information.
- Gather expense information.
- Identify your goals.
- Use a spreadsheet or app.
- Compare income to expenses.
- Automate as much as possible.
- Check weekly expenses.
Gather your income information
To make an accurate budget, you will need to compile information about your total household income. “If we have a paycheck, look at what really hits our bank account after taxes and after any other outings, like our 401(k),” says Ashley Feinstein Gerstley, author and founder of personal finance site The Fiscal Femme. “If we have other income, we can include it there.”
Your total monthly take home pay will give you a better idea of how much money is available to budget.
Gather expense information
“When we get into these expenses, we want to track some previous bank statements, credit card statements, if you’re up for it, going through the whole year,” says Feinstein Gerstley. “It can be a quick scan, but sometimes things only happen once or twice a year.” It’s important to create categories that are broad enough to cover all of your expenses, but keep in mind that having too many narrow categories can be overwhelming.
Factoring these expenses into your monthly budget can help you pay for them when the time comes. Feinstein Gerstley recommends creating “sinking funds,” which are savings accounts intended to fund a short-term goal or expense. These accounts are designed to help cover expenses that you know will arise, such as travel expenses for a friend’s wedding or semi-annual car insurance payments.
“Because we always plan down to zero, if we don’t include those things that don’t happen every month, like a trip or vacation or a vet bill, I like to set up sinking funds for them. “, Feinstein told Gerstley.
Identify your goals
Whether it’s a big goal like retirement or saving money for the holidays, Feinstein Gerstley says it’s important to set goals for this type of budget. In zero-based budgeting, your goals will dictate where your money goes. “I would think, OK, well, how much money do I want to spend on these goals?” said Feinstein Gerstley.
People who feel overwhelmed with goal setting should start small. “Small steps can make a huge difference,” says Feinstein Gerstley. “And I would say most of the time our goals are not linear. So just because I’m putting $10 a week into a real estate fund right now doesn’t mean it’s going to take me 10,000 years to save for my house.” Goals can be adjusted over time.
Here are some examples of goals for a zero-based budget:
- Saving for a future home purchase.
- Saving for retirement in a IRA.
- Creation of a sinking fund for vacations.
- Saving for a child’s education costs.
Use a spreadsheet or app
Choose a method that you are comfortable with and that is also easy and enjoyable. “You’re going to track everything you’ve spent money on,” says Taylor Westergard, money coach and founder of Evolving Money in Salt Lake City. “You can do this through apps, or you can just monitor this in a spreadsheet or bank balance.”
There are several popular apps available that support zero-based budgeting. Westergard recommends You Need A Budget, an app that costs $99 per year after a free trial, and EveryDollar, an app that costs $79.99 per year.
Compare your income to your expenses
At this point, it is not uncommon to realize that there is a shortfall between your income and your expenses. Although spending more than you earn can be a long-term problem, you can fix it now to avoid further problems.
“It’s a good realization because now you can act on it and say, ‘I need to cut my spending in a certain area to balance it out,'” Hayes says.
If so, here are three ways to revise your budget to zero, according to Feinstein Gerstley:
- Rework your expenses.
- Change your goals.
- Make a plan to earn more.
“Those are the different levers we can move to make the budget workable,” Feinstein Gerstley said. “Perhaps you notice your phone bill going up. Is it time to call and negotiate or switch providers? This could be an opportunity to re-evaluate your spending.
While you may have some extra money left over after creating a traditional budget, that won’t be the case with a zero-based budget. You’ll want to make sure your income equals your expenses and your goals.
Automate as much as possible
When it comes to your expenses, try putting things like utility bills, mortgage payments, and other fixed expenses on an automatic payment schedule. “I think we need to automate as much as humanly possible,” says finance coach Delyanne Barros.
Automating payments can help ensure your bills are paid on time, every time. “I would say that maybe you use a spreadsheet for a month or two months just to really see what your numbers are,” Barros says. “And then I would quickly switch to an automated system.”
Check your expenses every week
You will want to monitor your spending and check your budget frequently. Since there won’t be any money left in your zero-based budget, you’ll want to pay close attention to your expenses and make sure they fall within the categories and goals you’ve set. “It’s something that needs your attention on a regular basis, and I would say at least once a week at a minimum,” Westergard says.
Pay attention to the categories you spend in and make sure they match your needs. “Let’s say you’ve earmarked $200 for groceries,” Westergard says. “If it was more or less than $200, that will tell you what you need to adjust, and if you need to allocate more money to the grocery category, allocate less, and you can move the money around a bit.”
Prudent credit card spending is especially important with this budget. “The biggest kryptonite of a zero-based budget is the credit card, because it might make someone feel like they have that extra cash at their disposal,” Barros says. “You should treat your credit cards like a debit card.”
Although it takes effort to maintain this type of budget, goal-oriented people may find zero-based budgeting effective. “It really is an amazing system,” says Westergard. “You have to be so mindful, and I really think that helps people save a lot of money.”