What is zero-based budgeting

What does zero-based budgeting mean?

Using every cent of your monthly income is encouraged while using the zero-based budgeting strategy. However, that does not mean going on an extravagant shopping trip. Important objectives like debt repayment and savings are all included in the plan, along with spending on leisure activities.

Giving every cent a purpose is the concept underlying the zero-based budget, often known as the zero-sum budget. This is how it works.

The goal of zero-based budgeting is to set aside 100% of your income for debt repayment, short- and long-term savings, and necessities and wants. By the end of the month, you want your income minus your expenses to equal zero.

Living paycheck to paycheck and zero-based budgeting differ in that the former allows you to achieve all of your financial objectives.

You can vary or repeat the categories and quantities of your monthly expenses. If you finish up under budget in a particular category at the end of the month, add the remaining cash to the budget for the next month. You can also transfer it to another area, like your emergency fund.

It’s the same idea as the envelope system, which divides up cash into envelopes according to several kinds of expenses.

Assume that your monthly income is $3,000. This is how your budget might appear:

Rent: $1000

Groceries: $375

Eating out: $75

Bills: $250

Insurance: $100

Gas: $250

Clothing: $75

Entertainment: $100

Emergency fund: $150

Retirement: $175

Credit card payment: $175

Student loan payment: $125

Travel fund: $100

Other: $100

Keep in mind that the remaining spending categories might be used for anything else after you’ve allocated money for the necessities. Do you wish to pay off a credit card in half a year? Include it in your spending plan. Purchase a home? Amount money aside for the down payment. Large vacation? Add some extra money to the travel fund.

Create a zero-based budget using a spreadsheet, pen and paper, or a budget app like You Need a Budget or Goodbudget.

Starting a zero-based budget: A guide

Take these actions to make sure you’re realistically budgeting your expenditure before you adopt this budget:

Be aware of your revenue. To determine how much money you have available, add up all of your monthly revenue from sources other than your paycheck and benefits.

Keep tabs on your spending for several months. By becoming aware of your usual spending patterns, you can establish a structure that you can utilize in the future. You’ll see where you want to allocate more money and where you may make savings.

Sort through your expenses. Determine all of your costs and priorities, together with your requirements and wants, emergency savings, other savings objectives, and debt repayments.

What amount of money is appropriate for each category? Follow the 50/30/20 rule. This strategy allocates 50% of your income to necessities, 30% to wants, and 20% to savings and debt payback.

The benefits and drawbacks of zero-based budgeting

The advantages

You are always aware of how much money comes in and goes out thanks to the zero-based budget. By doing this, you may avoid wasting money that you don’t have.

This is a really good method if you haven’t tracked where your money is going. It is also good if you feel like you don’t have control over your money or spending.

Also, this technique is adaptable. This is beneficial if you’re not experienced with money management.

The drawbacks

Maintaining a zero-based budget takes a lot of time. You will need to keep a careful and regular eye on your expenditures if you want to hold yourself responsible. It’s not the only difficulty you might run against.

One issue that may arise with it is the abundance of variable costs. The zero budget may not leave you with enough money on average if you don’t account for your unusual expenses. These erratic costs could include buying gifts for friends and family, going to their wedding, or fixing a broken phone.

However, there is a solution to this: make a special financial allocation for these expenses. Establish a savings account and add to it every month, keeping it apart from your emergency fund and other savings objectives.

If your income is inconsistent or unpredictable—for example, if you work as a freelancer or an hourly employee with variable schedules—you may encounter issues with the zero-based budgeting approach. Use last month’s revenue for this month’s budget if you don’t always know how much money you’ll need to set aside. Keep in mind that you must first accumulate a buffer of one month’s worth of money.

Check if you are a good fit for zero-based budgeting

You’re prepared to try the zero-based budgeting technique now that you understand its basics. Try a different approach to budgeting if this one doesn’t work for you. Also, seeing a financial advisor could be beneficial if your financial situation is complicated.