What Is Zero-Based Budgeting?

At some point in nearly everyone’s life, people wonder if there’s a better way to manage money flow. Maybe you want to take care of debt, save more, or just be better at tracking your spending. For most things that have to do with money, budgeting is a valuable tool. 

Simply knowing how much money is coming in and going out only takes you so far. If you want to reach your financial goals faster, you need to think about where your money goes, and why. That’s where zero-based budgeting could come in handy. This method helps you track your expenses to ensure that you’re using your income effectively and saving money each month.

Let’s take a deep dive into zero-based budgeting, including its pros and cons, so you can decide if it'll work for you. 

What Is Zero-Based Budgeting?

Zero-based budgeting is a budgeting strategy that gives every dollar in your paycheck a purpose. Your household income minus your expenses, including savings, should equal zero at the end of each month. Your monthly expenses may include:

• Household expenses like rent and utilities

• Transportation costs

• Debt payments

• Healthcare expenses

With zero-based budgeting, every dollar of your income is accounted for. So if your household brings home $5,000 each month, all of the money you use and save that month should equal $5,000. 

Here's an example of a zero-based budget for a $5,000 monthly income:

It’s easy to understand why zero-based budgeting could help you stay on top of your finances. Accounting for all of your expenses and knowing where your money is going is the best way to make sure you can save and cover your costs without getting into debt (or adding to existing debt). 

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How to Use Zero-Based Budgeting

Here are the steps to create your zero-based budget plan.

1. Figure out your monthly income

Your paycheck may not represent your total income. Also account for any side-hustle earnings, income from investments, or any other money you have available during the month.

2. Plan around your lowest-earning month

If you have variable income, it’s important to base your budget on the lowest amount you expect your income to be. That way, you’re less likely to have a shortfall. And then, any extra money you have is money you can use to pay off debt or spend on wants. 

3. Calculate your monthly expenses

Sit down with all of your bills and bank statements and figure out how much money you spend every month to keep your household running. Add up your utility bills, rent or mortgage payments, medical expenses, transportation costs, and other living expenses. If you spend money on it, it needs to be a part of your household budget.

4. Set a savings goal

Once you’ve added up your expenses, figure out a reasonable amount you can save each month. Make that monthly savings target a line item in your budget.

5. Make sure the numbers work

With zero-based budgeting, your household income minus your household expenses and savings should equal zero. 

If you find that your expenses exceed your income, it could be a sign that you need to cut down your spending or explore debt relief options. On the other hand, if your expenses are less than your income, you could start saving more money or use the cash to pay down your debt more quickly.

The most important parts of zero-based budgeting are:

• Your income and expenses should zero out when you stick to your budget

• You know exactly where your money is going and why

The more disciplined you are about balancing your budget each month, the less likely you are to use your money on expenses that don’t offer you a lot of value.

6. Track your expenses every month

Consistency is key when you’re doing zero-based budgeting. Try to review your household budget every month, and do your best to avoid overspending. Everybody slips up from time to time, but if you’re keeping track of your spending, it’s easier to correct your mistakes and hit your financial goals.

Also, don’t hesitate to explore different tools that make it easier to budget. There are a number of free or low-cost budgeting apps that can track your spending and assign purchases to different expense categories, making it easier to keep tabs on your money.

Download our FREE budgeting worksheet to get started. 

7. Make adjustments as needed during the month

You may find that some of your expenses come in higher or lower than expected. During the month, review your budget and make changes as needed, such as reducing spending in one category if another seems to be getting more expensive. If food costs are up, for example, you may need to spend less on leisure until your income increases.

8. Compare planned versus actual spending

At the end of each month, compare the amount you actually spent in each category to the amount you initially budgeted for. This should help you rework the following month's budget so that it's accurate and helpful. 

Two Household Budgeting Guidelines to Help You Stay on Track

Once you create a budget, you’ll know how much money you’re spending on household expenses. But that isn’t necessarily the same thing as knowing how much you should be spending on household expenses. Here are two guidelines you can use in addition to zero-based budgeting to stay on track.

The 50/30/20 rule

One simple way to allocate your household budget when you’re using zero-based budgeting is the 50/30/20 rule. This budgeting guideline states that you should put:

• 50% toward needs

• 30% toward wants

• 20%  toward debt payment and savings.

To use this method in conjunction with zero-based budgeting, keep track of the exact amount you spend on needs, wants, savings, and debt. Make sure your budget comes out to zero each month.

The household expense chart

If you’re looking for a more in-depth breakdown of how much you should spend on various expenses, you can use this chart as a guideline:

Following this recommendation could help you stay on top of your spending and work toward savings goals. But remember—this is just a guideline. 

Everybody’s budget is unique, so if you find yourself spending more on one category or another, don’t sweat it. As long as you’re breaking even at the end of the month—and not going into the negative—it means zero-based budgeting is working for you.

Before you start zero-based budgeting (or any other budgeting method, for that matter), it’s important to understand the pros and cons of using this system.

Zero-Based Budgeting Pros

Zero-based budgeting helps you focus on the money coming in and out each month. 

It can be an easy way to stay on top of your finances and save money. 

Zero-based budgeting could help you pay down debt and save for specific goals.

If you’re dealing with a lot of debt, this method could help you allocate funds to pay off that debt. Similarly, if you want to save up for a vacation, a home, or another major purchase, knowing how much money you have to spend and identifying where you could cut your spending could help you put money aside.

Zero-based budgeting could help you avoid new debt.

By making sure your budget zeroes out at the end of the month and doesn't go into the negative, you can avoid getting into debt (or more debt).

Zero-Based Budgeting Cons

Zero-based budgeting requires you to stick to a plan and put in time and effort. 

Zero-based budgeting could be frustrating in the first few months as you dial in your spending. Many people don’t know exactly where their money goes. It’s okay to take some time to nail it down.

Zero-based budgeting doesn’t account for budget fluctuations.

Zero-based budgeting is that it doesn’t necessarily take seasonal expenses into account. For example, during the winter, you might spend extra money on your heating bill. That money needs to come from somewhere, and finding the cash to cover the expense could throw your budget off. Similarly, during the holidays, you’re likely to spend extra on gifts, and your budget may not account for that.

Zero-based budgeting doesn’t have a specific line for unexpected expenses.

It’s not a given that you’ll have the same set of expenses every single month. During certain periods of the year, your bills may be higher. 

The holiday season, for example, tends to be very expensive. Similarly, if you have multiple friends getting married one summer, you could end up with a couple of months with larger-than-average bills.

Also, you never know when you’ll run into an unexpected expense. It could be a car repair, a home appliance you need to replace, or a medical bill.

If you plan to do zero-based budgeting, it’s critical that you put some of your monthly income aside for surprise expenses so that you can cover them as they come up. A good bet is actually to have a separate emergency fund for unplanned bills.

Zero-based budgeting has no margin.

You may want to include a buffer category in your monthly budget for surprise costs. 

Just as you might put “cable” or “groceries” as a line item in your budget, you may want to include a “miscellaneous” line item for surprise costs you can’t predict. 

If you allocate $50 or $100 a month to that category, it gives you some wiggle room in case other categories end up costing you more than expected. 

Remember, too, that having a buffer in your budget could be your ticket to avoiding more debt. Without a buffer, expenses you can’t afford to pay right away may end up on a credit card. And if you’re in the process of trying to pay off debt, that’s the last thing you want. 

Zero-based budgeting doesn’t address freelance or variable income.

It’s especially important that you have a buffer if you’re self-employed with a variable income. In fact, if you don’t earn the same amount of money every month, it’s best to base your budget on your lowest anticipated monthly income.

Let’s say over the past 12 months, the most you’ve made in a month is $5,000, and the least you’ve made is $3,000. You calculate your average monthly earnings at $4,000. Instead of using your average monthly income as your budget foundation, you’re better off basing it on your lowest monthly income. 

If you manage to keep your expenses to $3,000 or less, you’ll have extra money any time your earnings exceed that point. That gives you more opportunity to add to your savings, pay down debt, or treat yourself to things you normally can’t afford. 

If you base your budget on $4,000 of earnings and you only make $3,000 one month, that puts you at risk of more debt. 

Zero-Based Budgeting vs. Other Methods

Zero-based budgeting has several benefits, but it's not your only option. Here are some other budgeting systems that may work for you.

The envelope method

With envelope budgeting, you put physical cash into different envelopes that are labeled for different expenses. One envelope might be for groceries, another might be your dining out money, and another might be groceries. This allows you to visualize with your own eyes how much money you have left within each category as you go about your spending.

While the envelope system is easy to follow, physical cash can be cumbersome for fixed payments that you pay by check or that come from your bank account, like rent, your cellphone, or streaming services. Misplacing cash is another risk, which could be a huge problem. And you may have trouble using the envelope method to pay off debt unless you specifically allocate an envelope for that purpose.

The 50/30/20 rule

The 50/30/20 rule has you spend 50% of your income on needs, 30% on wants, and 20% on savings and debt payments. It's an easy system to follow. If you have a lot of debt, you may need to allocate more than 20% of your income to paying it off if you want to do so quickly.

The 50/15/5 rule

The 50/15/5 rule allocates 50% of your income to essential expenses, 15% to long-term savings, and 5% to short-term emergencies. The rest of your money is yours to use as you please. 

This method could be useful if you're trying to pay off debt. But you'll need to be prepared to prioritize debt payments using the 30% of your income that isn't already allocated.

Zero-based for debt payoff

This method is almost identical to zero-based budgeting, only your debt is the priority. Money you don't need for essential bills is used to pay off debt. You could combine it with a DIY strategy: 

• Debt snowball method, where you pay off debts in order of smallest balance to largest 

• Avalanche method pays off debts from highest interest rate to lowest

This method could be effective for people who are focused on getting rid of debt. 

Is Zero-Based Budgeting the Solution, or Do You Need More Help?

If you’re struggling with your expenses, zero-based budgeting could help you get a better handle on them. But it may be time to take further action. 

If you have a lot of debt, Freedom Debt Relief is here to help you understand your options for dealing with it, including our debt settlement program. Our Certified Debt Consultants can help you find a solution that will put you on the path to a better financial future. Find out if you qualify right now.