The core principle of the zero based budgeting method is to encourage you to use every single penny from your monthly paycheck. This doesn’t mean blowing it all on a shopping spree but means you want to utilize it all.
The idea behind the zero based budget (sometimes referred to as the zero-sum budget) is to make sure every single cent and dollar has a purpose. So how does it work?
What is a Zero-Based Budget?
A Zero-Based Budget is a type of budgeting that makes you allocate all of your monthly incomings (your salary) to savings, debt and expenses. The goal is that your salary subtracted by your expenditure equals zero at the end of every month.
You can make the system as complicated or as simple every month. You can keep the same categories and amounts each month or mix it up depending on how you are feeling. For simplicity, we would suggest keeping it the same every month to start before then adjusting it after a couple of months.
If you have some money remaining at the end of the month then you can add it to another category at the beginning of the next month. Before you immediately add it to your going out fund think about whether it could be better used in your emergency fund or to pay off toxic debt. It is a very similar concept to the envelope system which means you distribute physical cash to different envelopes that you then use for payments throughout the month.
Let’s give an example.
Say you make $2,900 in a month.
|Credit card payments
|Student loan payments
Amount Left $0
You can build your zero-based budget using an app like YNAB (You Need a Budget) or by using a spreadsheet. Or you could go back to basics and use a pen or paper.
Where to Start With My Zero Based Budget
Before you jump into creating a zero-based budget make sure to stop and plan for a minute. Planning at the beginning will help in the long run.
Determine your total income. Add up your total paycheck, benefits, and then other sources of income to figure out exactly how much money you have to work with.
Keep track of your expenses for a few months. Figuring out what you typically spend each month, and on what, will help you create a structure that you can follow going forward. Keeping track for a month will help you easily identify where you are spending too much money and where you can cut back. Remember, at this point, it is just an assumption and after a few months you’ll have a better understanding of your spending habits.
Organize your expenses into categories. Look through all of your priorities (things you have to pay) and your expenses. Split them into needs, wants, and debts/savings. If you want to go visit your family then create a travel fund category. If you want a new bike, make that a category too.
You might be wondering how much to allocate to each category. Capital Bean always recommends the 50/30/20 rule. If you follow this approach then 50% of your net income goes to what you need to purchase, 30% goes to what you want to purchase and 20% goes towards savings and debt repayments.
Pros and Cons of the Zero Based Budgeting Method
The zero-based method makes you very aware of how much money is flowing in and out of your life. At the core, this could prevent you from spending what you don’t have because once you’ve spent the cash it is physically gone.
If you have no idea where your money is going and you haven’t tried budgeting before then this is a really good method. It will give you an easy way to take control of your money and spending because it makes you hyper-aware of where each cent is going. It’s also customizable which means you can change the numbers and categories from month-to-month.
If you follow this method properly then one of the cons is that it takes up lots of time. To make sure you are held accountable you’ll have to pay attention to your spending and expenditures constantly. This isn’t the only thing that could be an issue.
One of the main issues with this type of budgeting is that in day-to-day life there are many unexpected expenses that you don’t see coming. This can really throw off your budget. This means that your “other” category could be quite high or fluctuate wildly from month to month.
These variable expenses might include unexpected bills, purchases on holiday or even helping out a friend.
There is a way to help with this – set up another pot specifically for these costs. Create a separate savings fund that is not linked to your debts or emergency fund. Money that you will only touch in case of a real emergency.
The zero based budget doesn’t work for all income types. It might not work if you have a variable salary month-to-month. If you make $6,000 one month and then $3,000 the next month your average salary will be $4,500 but in the month where you make $3,000 it might look like you’ve way overspent on expenses.