Control Your Finances With Zero-Based Budgeting

How to give every dollar a job.

There are a lot of budgeting systems out there, and many people swear by the one they use. I want to highlight the one that I use personally: the zero-based budget.

With a zero-based budget, also known as a zero-sum budget, your income minus your expenses equals $0. The goal of the zero-based budget is to assign a purpose to every dollar. This helps you track where your money is going, decide where you need to make adjustments and be more intentional.

The zero-based budget is designed for take-home pay, so it assumes taxes have already been taken out and that you’ve contributed to a 401(k) or other retirement account via paycheck deduction.

How to Create a Zero-Based Budget

To make things easy, you should use a single checking account. Think of your budget as divided into two broad categories: inflows and outflows. Inflows include your income, although you could count a gift or other funds as an inflow. Outflows include expenses, savings and donations. Money comes into this account at the beginning and middle of the month, and all the money leaves by the end.

Design a draft budget with estimates of each income source. It’s best to use a spreadsheet with some simple formulas to ensure all your numbers are correct. You could also use a budgeting app like You Need a Budget (YNAB) but I like to use a custom spreadsheet. Plus, unlike YNAB and other tools, it’s free.

Create a Budget column and an Actual column. In the Budget column goes an estimate of what will be allocated to the category, while the Actual column shows the real amount. Allocate money to your fixed expenses, then variable expenses, then savings.

If you work a regular amount of hours, you can probably safely guess what your income is going to be. If you have an irregular income, you can try adding a lower-end guess in the Budget column and then adjust your expenses or savings if it’s higher.

Once you have an estimate of your income, you can start allocating this money to various expenses. There will be some expenses that don’t change from month to month, such as internet, insurance and rent. You can add these fixed amounts into the Actual column. Others will fluctuate, such as groceries, restaurant expenses and utilities. Just try to pinpoint an average of what you spend in each category and adjust as needed. Make the necessary expenses the priority here, followed by discretionary expenses.

Then you have your savings and investments. These might include (for a couple) two Roth IRAs, a brokerage account, a long-term savings account and a short-term savings account. If your goal is to max out a Roth IRA, you know exactly how much per month to contribute. Other accounts have no limits, so the amounts may change. Savings and investments are treated as expenses in this budget system, although you can separate them in your spreadsheet.

The zero-based budget requires you to make adjustments in real-time during the month. If you underspend in one category, that’s more money that can go into another. You have two primary levers to adjust your budget as needed: your discretionary expenses and your savings. During months when you have more income, you can spend or save more. During months when you have less, you can simply cut back on either discretionary expenses or savings.

Here’s an example of a zero-based budget. Let’s assume two partners both work and get paid twice a month. That’s four paychecks total that get allocated to various spending and saving categories.

Inflows are represented as positive numbers and outflows are represented as negative numbers. The total adds each category which should equal zero. If the total is greater than zero, you need to move that amount to one or more categories. If the total is less than zero, you need to subtract from one or more categories.

The short-term savings category is what makes the zero-based budget work, because whatever you have left over on the last day of the month, you can transfer this exact amount to this short-term savings account to zero out your budget. Or if you find that there’s much more leftover than you want to save, you can use this as permission for more discretionary spending before the month is over.

Why have a short-term savings account? You will likely have non-monthly expenses; expenses that come up once a year, irregular expenses, etc. Adding a little bit of money each month to a short-term savings account allows you to cover these expenses without disrupting your regular budget. Say you spend $500 on a car repair. Instead of adding that $500 to your budget for the month, which will mean taking away from another category, you can use the short-term savings to cover it. Some months this will be a small amount, others it will be a large amount. The key is to keep replenishing the account throughout the year even as you take from it on occasion.

At the beginning of the next month, you start all over again with a clean slate. Nothing rolls over except for a fixed amount that stays in your checking account as a buffer. For example, you can keep $200 in your account to ensure it never gets overdrawn, especially in the middle of the month when you’re waiting for another paycheck.

The Pros and Cons of a Zero-Based Budget

The zero-based budget is great if you like to meticulously control where your money goes and you take an active approach to budgeting. It helps you set goals as it allows you to see where money needs to be moved from category to category and where you need to make changes in the future. It’s also highly customizable. You can add as many spending or savings categories as you like, and you can account for multiple income sources, not just regular paychecks.

The bad part is it can be complicated. This is not a passive budget. It requires you to have an intimate understanding of every dollar that passes through your checking account, and it requires a lot of work to maintain. If you choose this budget system, you’re probably going to have to check and update it at least once a week if not more to make sure you’re on track.

Implementing a zero-based budget is easier when all your household income sources go to a single checking account and can then be allocated to various categories. This means combining finances with a partner for simplicity and optimal results.

Give the Zero-Based Budget a Try

If you’re still figuring out what kind of budget you want to use to manage your personal finances, the zero-based budget is a great choice. While it requires time, it makes you aware of what you’re spending and where your money is going, and it helps you be more intentional with your money.