What Is Zero-Based Budgeting, and How Can It Help You?

What Is Zero-Based Budgeting, and How Can It Help You?

Budgeting is something many people struggle with. Even those who make it a point to track their money often find they have trouble seeing where their money is going. This is where zero-based budgeting can help.

First, we must understand the most common budgeting methods and why they often end up not working for people. The following are two of the most commonly recommended methods:

The Basic Budget—In this budgeting system, you are instructed to write down all of your expenses and subtract that number from your income. While this generally works, unless your bills add up to more than your income, there will be money left over. Oftentimes, people see this as “extra” money and may spend it—often little by little. By the end of the month, they feel like they don’t know where their money went.

The Percentage-Based Budget—This type of budget is better than the basic budget in many ways, but it doesn’t compare to the effectiveness of the zero-based budget. Designed to simplify budgeting and spending, the percentage-based budget divides your expenses into three categories: needs, wants, and savings. The problem with this method is that savings usually has the lowest percentage allocated, which can spell disaster when you’re trying to save for large purchases (such as real estate), add to retirement funds, or reduce debt. For those who are looking to make real progress in any of these areas, percentage-based budgets fall short.

So, What Is Zero-Based Budgeting?

Compared to other budgeting strategies, zero-based budgeting doesn’t leave room for money to go unallocated. When creating a zero-based budget, all of your money is put into categories so that your income minus expenses equals zero. This does not mean you will have zero to spend on yourself or to save, it just means that these amounts must be allocated. To summarize, a zero-based budget means that every dollar that comes into your possession is given a job to do.

How to Allocate Your Funds

Zero-based budgeting works by making space for all the money that you bring in. instead of leftover money going to “miscellaneous” or being simply spent, zero-based budgeting encourages savers to devote extra funds to baby steps. A baby step could be paying off a credit card with a high balance, creating an emergency fund, or saving for retirement. Though it may sound like a lot of work, setting up a zero-based budget will actually make handling finances easier.

When it comes to allocating funds, you will, of course, input your income and expenses, but you will also create categories for the things most of us spend money on but don’t really think about. This can include monthly subscriptions, daily coffee runs, or any other small expenses that can really add up over time. After you enter all your expenses, you will devote your income to each category until you have successfully allocated each dollar. You can still have a miscellaneous category, though it should be small and reserved only for expenses that you may have forgotten about when creating your budget.

Your first baby step should also be a category, and how much you allocate to it will be determined by how fast you would like to reach this milestone. For example, if you would like to have an emergency fund of $1,000 in six months, you will need to determine how much you will allocate to this baby step weekly, bi-weekly, or monthly to reach your goal.

Though you may be tempted to fast-track your savings, make sure you set your other categories so you will not have to constantly chip away at your baby step funds. For bills and other monthly expenses, it will be easy to determine how much to allocate, but for miscellaneous, entertainment, and baby steps, it can be a little trickier. To make things easier, after you enter your recurring expenses, decide if you are comfortable with devoting more of your residual funds to reach your baby step goal faster.

Is Zero-Based Budgeting Right for You?

Zero-based budgeting is a great tool for anyone who has struggled to create and stick to conventional budgeting tools. Creating a zero-based budget allows you to view sticking to a budget in a way that puts attention on both your long-term and short-term goals. If you have tried and failed to use other budgeting methods, zero-based budging may be right for you.