What Is Zero-Based Budgeting?

A zero-based budget is a budgeting method built around one simple rule: your income, minus your expenses and savings, should equal zero every month. It gives every dollar in your paycheck a purpose. A dollar might be assigned to a household bill, an unsecured debt, or a savings account. Explore this option when working toward a financial goal or playing with good ways to track spending.

Though knowing how much money comes in and goes out each month is a start, there’s more to be done. Reaching your financial goals faster means understanding where every dollar goes, and why. A zero-based budget helps you track what you’re using money for so that you can use your income effectively and build savings.

Let's review zero-based budgeting, including its pros and cons, so you're able to decide if this strategy meets your needs.

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. The formula: income - expenses - savings = $0.

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’re covering your costs. It helps you prevent 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

Start with your paycheck. Also account for side-hustle earnings, income from investments, and other money you earn during the month.

2. Plan around your lowest-earning month

When you have variable income, or income that changes month–to-month, it's important to budget as if it’ll be a tough month. Leave a buffer. That way, you're less likely to run out of money. If you have money left over, you can put it toward reducing debt or covering wants.

3. Calculate your monthly expenses

Sit down with all of your bills and bank statements.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

Calculate a reasonable amount to save each month. Make it a line item in your budget. If you decide to save $500 monthly, budget for $500 toward savings. (Some budgets only include income and expenses. Zero-based budgeting also budgets for savings. It’s all-inclusive.)

5. Make sure the numbers work

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

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 budget for saving more money or paying down debt faster.

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, 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 spends more than they planned to from time to time and that’s OK. When you're budgeting, it's easier to correct your mistakes and hit your financial goals.

Explore tools that make it easier to budget. There are a number of free or low-cost budgeting apps. These track your spending and assign purchases to different expense categories. The idea is to make it easier to keep tabs on your money.

Download our FREE budgeting worksheet to get started.

7. Course-correct as needed during the month

Some of your expenses may come in higher or lower than expected. Adjust your budget as needed; you might reduce spending in one category when another gets more expensive. When food costs are up, for example, you might budget less for leisure until your income increases.

8. Compare planned versus actual spending

When the month ends, compare your actuals, the amount you actually spent in each category, to your estimates, the amount you initially budgeted for. This should help you rework the following month's budget so that it's accurate and helpful.

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. That’s different from knowing how much you should be spending on household expenses. Here are three guidelines that go beyond zero-based budgeting to help you stay on track.

The 50/30/20 rule

The 50/30/20 rule helps you understand how much money you should spend on needs, wants, and other things. 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 tandem 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.

Prioritize essential expenses

Budget for essential categories first: housing, utilities, food, and transportation. Direct remaining dollars toward debt payments, savings goals, or discretionary spending. The idea is to guarantee nothing important slips through the cracks.

The household expense chart

For a more in-depth breakdown of how much to budget for expenses:

These guidelines might help you organize how you spend your money so you can work towards your savings goals. Remember, these aren’t hard-and-fast rules. Tweak the numbers so they make sense for your situation.

Everybody's budget is unique. When 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.

Zero-Based Budgeting Pros

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

This method offers a straightforward 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 reduce 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.

When your budget zeroes out at the end of the month instead of dipping into the negative, you avoid getting into debt (or adding more debt).

Zero-Based Budgeting Cons

Zero-based budgeting requires you to stick to a plan even when things get tough.

Zero-based budgeting could be frustrating in the first few months as you dial in the finer details of your budget. 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.

One drawback of zero-based budgeting is that it doesn't specifically account for seasonal expenses. For example, during the winter, you might spend extra money on your heating bill. That money needs to come from somewhere. Finding the cash to cover the expense could throw your budget off. Similarly, during the holidays, you're likely to spend extra on gifts. Your budget may not account for that. Not until you get good at predicting seasonal expenses, anyway. It gets easier.

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

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.

Unexpected expenses are hard to predict. 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 you're prepared to cover them as they come up. 

Beyond a general emergency fund, some people find it helpful to set up small sinking funds for predictable costs that don't happen every month. A sinking fund is a dedicated amount of money that you’ve set aside for predictable future expenses. Because things like new tires aren’t emergencies. If you have a car, you’ll need them. Sinking funds could also cover annual insurance premiums or holiday gifts, or any other future expense. Setting aside a set dollar amount each month toward one of these categories helps you avoid dipping into the rest of your budget.

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 TV" or "groceries" as a line item in your budget, you may want to include a "miscellaneous" line item for surprise costs that are harder to 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.

Having a buffer in your budget could help you avoid more debt. Without a buffer, expenses you're not able to pay right away may end up on a credit card. When you're working to resolve debt, that's the last thing you want. A buffer could help.

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

It's especially important that you have a buffer when 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 typically calculate your average monthly earnings at $4,000. Instead of using your average monthly income ($4,000) as your budget foundation, you're better off basing it on your lowest monthly income ($3,000).

If you manage to keep your expenses to $3,000 or less, you'll have extra money when your earnings exceed $3,000. It opens up opportunities to add to your savings, pay down debt, or treat yourself to things that are normally out of reach.

If you base your budget on $4,000 of earnings and you only make $3,000 one month, that puts you at risk of needing to take on debt to cover the difference.

Zero-Based Budgeting vs. Other Methods

Though zero-based budgeting has several benefits, it’s not your only option. The envelope method, the 50/30/20 rule, or the 50/15/5 rule might work better for you. You might prefer an alternate version of zero-based budgeting to reduce debt faster. Or, you might combine budgeting methods.

The envelope method

The envelope method has you put physical cash into envelopes labeled for different expenses. One envelope might be for groceries, another for dining out, and another for entertainment. This shows you, by the bulge of the envelope and the dollars within, how much money is left in each category as you spend.

It doesn’t work well for all categories. Physical cash can be hard to manage for payments made by check or from your bank account: rent, your cellphone bill, or streaming services. Misplacing cash is another risk, which could be a problem. You may have trouble using the envelope method to prioritize debt payments unless you set aside a specific envelope for that purpose.

The 50/30/20 rule

The 50/30/20 rule has you spend 50% of your after-tax income on needs, 30% on wants, and 20% on savings and debt payments. It's a simple system to follow. If you have a lot of debt, you may want to put more than 20% of your income toward reducing it (if you can afford it).

The 50/15/5 rule

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

Though this method could be useful when you're trying to pay off debt, you’ll need to be proactive about it because the rule doesn’t account for debt specifically. Be prepared to prioritize debt payments using some of the 30% of your income that isn't assigned to anything specific.

Zero-Based Budgeting to Reduce Debt Faster

In this zero-based budget, your debt is the priority. Money left over after essential bills goes toward reducing debt. You might combine it with a DIY strategy:

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

• Avalanche method, which pays down debts from highest interest rate to lowest

This method could be effective for people getting rid of debt.

Is Zero-Based Budgeting Right for You?

Zero-based budgeting could help you get a better handle on your expenses. You might still explore other ways to manage unsecured debt, such as debt settlement or a debt management plan.

Freedom Debt Relief works with people who have a lot of unsecured debt, through our debt settlement program. A certified debt consultant can help you review your options and help you find a solution suited to your situation. Quickly find out if you qualify.