If you’re looking to get a better handle on your finances, you’ll want to set a budget. Knowing how much money is coming in and going out each month can help you meet your financial goals. Yet, many Americans still don’t have a budget and if that’s you, it might be because you haven’t found the budgeting method that works best for your financial situation.
What Is a Zero-Based Budget?
A zero-based budget or zero-sum budget is when you align your spending to match your monthly income down to the penny. In other words, you budget every dollar you earn. It’s great for people who are tired of living in debt or paycheck to paycheck.
Normally, with a traditional line-item budget your goal is to spend less than you earn. Traditional budgets focus on making sure there’s some income leftover after all your budgeted expenses are covered.
With a zero-based budget, you give every dollar a job. If you earn $3,500 per month, you’ll budget that you will use all of that $3,500 each month. You don’t have to spend every dollar you earn with a zero-based budget. In fact, you should still save and pay off debt, but you’ll assign a specific dollar amount to these categories each month. In short, every dollar you earn will have a specific place in your budget.
Key benefits of zero-based budgeting include being able to:
- Assign every dollar a purpose
- Base your budget on real amounts and not projections (more on that below)
- Maximize your income and stop wasting it on impulse purchases
- Stop living paycheck to paycheck
How Does a Zero-Based Budget Work?
If a zero-based budget sounds like something that could work for you, the key is setting it up properly. Start the process with the goal of budgeting every penny you earn. Follow these steps to get started.
Step 1: Start by Tracking Your Spending
Begin with tracking your spending. Your budget works better when you base it on realistic numbers. You may think that you spend $350 per month on food but then when you track your spending, you find out that you actually spend $550.
Tracking what you spend helps create awareness and can remind you of budget categories you might have otherwise overlooked. Set yourself up for success by tracking one to three months of expenses.
There are two main ways to do this: manually or automatically.
If you’re old school, you may want to track everything by hand and save receipts. But this can get tedious quickly and may deter you from wanting to finish your budget. Plus, you run the risk of missing a transaction or making a mistake when calculating it.
If you’re more interested in seeing the results than going through the process, consider taking a more streamlined approach when tracking your expenses and use a tool like Personal Capital or PocketSmith. Automated budgeting tools easily connect to your bank accounts to access all your transactions and categorize your spending. PocketSmith helps you track multiple streams of income (both for your day job and side hustle). They also offer cash flow forecasting features and automatically track your bank transactions. From there, you can label and categorize your spending and even search for past transactions.
Step 2: Determine Your Income
In zero-based budgeting, you need to know your income. You want to know how much you’re making each month but also break it down by paycheck or by week. Your income may vary month to month, especially if you have numerous streams of income. But you want this number to be as close to accurate as possible.
Eventually, you’ll budget your spending based on last months’ income.
If you haven’t saved up at least one month’s expenses yet don’t worry. Just add up your paychecks from last month and use that as a starting point. If you earn a variable income, use the average from the last three months.
Related: How to Build an Emergency Fund
Step 3: List Your Spending Categories
Determine all your fixed and variable expenses. Fixed expenses may be things like your rent or mortgage, car payment, insurance, and cell phone bill. Variable expenses include your groceries, gas, utilities, entertainment, and dining out.
Once you’ve listed out several spending categories, review your spending over the past few months to make sure you’re not forgetting anything. Don’t forget about costs like investment contributions and credit card payments.
Also, don’t forget about periodic expenses. You may incur costs quarterly or annually so be sure to budget for these too. Break up a periodic expense and add it to your budget so you’re preparing for it each month. For example, if you and your spouse have two cars and the annual registration fee is a combined $300, budget $25 for this category each month.
Step 4: Budget Down to Zero
Once you have all your spending categories listed out, start budgeting down to zero. Take your income and allocate your money to each spending category until you’ve utilized every penny. This way, each dollar has a job.
A budgeting tool that’s great for this is YNAB – YNAB stands for you need a budget. The app helps you track your spending and budget down to zero each month. If there’s anything leftover, YNAB automatically allocates this for the next month. This is an easy way to eventually get one month ahead.
Consider using the ‘pay yourself first’ strategy with your zero-based budget. This strategy prioritizes savings over spending, so as you work on your budget, you’ll allocate money to your savings goals first. Once you do that, you can allocate money for other expenses, such as rent, food, and more.
Whether you start by allocating money towards saving or your expenses, you should make sure every penny you earn is accounted for in your budget. If you need to, create a category for miscellaneous purchases. If you find that it’s challenging to budget for every minor expense that doesn’t qualify as an emergency, this is a great solution to help your zero-based budget stay on track.
Zero-Based Budget Example
Ready to see a zero-sum budget in action? Here’s what it looks like for someone who is bringing home $4,200 per month.
- Mortgage: $900
- Groceries: $350
- Auto Insurance: $90
- Car Loan: $250
- Internet: $79
- Cell Phone: $100
- Daycare: $500
- Gas: $160
- Utilities: $205
- Clothes: $75
- Entertainment: $200
- Restaurant Meals: $200
- Miscellaneous purchases: $200
- Credit Card Debt Payments: $500
- Savings: $391
How to Get One Month Ahead
Zero-based budgeting works best when you are able to get at least one month ahead. That way, you can budget with the previous month’s income. This is especially helpful if your income varies month by month.
This is why the most accurate zero-based budget is based on money you’ve already made. It takes the guesswork out of trying to determine how much to spend on each budget category.
If you want to get one month ahead, here are a few things you can do.
- Set up your zero-based budget to maximize savings so you’re stashing away more money (If you need $4,000 to get one month ahead, set $500/month for eight months or $1,000/month for four months)
- Automate savings – Acorns is an app that helps you invest spare change and makes automatic savings contributions.
- Get a side hustle to speed up your savings process
- Use a windfall like a bonus or refund
- Pay off consumer debt to lower expenses and free up more money to save
Stick to It
Once you understand your expenses, your income, and have your zero-based budget set up, all that’s left to do is stick to it! Budgets only work if you put the effort into them. As you get more familiar with your finances, go back and tweak your budget to better reflect your long-term savings goals and your lifestyle.
With a zero-based budget, it’s easy to make your money work for you. You don’t have to wonder where your money went or why you’re unable to reach certain financial goals. You’ll know where every dollar goes and can use this method to increase your savings.