What Is Zero-Based Budgeting?
Whether you’ve just started budgeting or you’ve been at it for years, you may find yourself in this predicament: You think you’re keeping up with your money, but some of it seems to grow wings and flutter out the window at night when you’re sound asleep.
Guess what? Your money isn’t magically escaping. You just need to start using the zero-based budgeting method to give every dollar a job each month. Here’s everything you need to know to make this happen.
What Is Zero-Based Budgeting?
Simply put, zero-based budgeting is where all your income minus all your expenses equals zero.
This means that all the money going out should be the same amount as the money coming in.
Your money won’t disappear when you’re watching and assigning every single dollar. This is why you need a zero-based budget.
Zero-Based Budgeting vs. Other Budgeting Methods
Before we explain how to make a zero-based budget, let’s look at a couple other budgeting methods.
Never-Check-In Budgeting Method
This is a common method for new budgeters. They set up a budget, allot their money to each budget line, and then place everything left over into “miscellaneous.” Throughout the month, they never check in to see if their planned totals are the same as what they’ve actually spent. They never check in on that miscellaneous money to see what it’s doing, either. The next month, they figure everything will be the same and use the previous budget in a copy-and-paste fashion.
There are two main flaws to this method. First, without tracking their spending, these “budgeters” don’t know if their plan matches their actual lifestyle. Second, putting all that extra money into a catchall is dangerous. Just like your house keys when you’re running late for an important event, that money’s going to get lost.
A zero-based budget can have a miscellaneous budget line of around $50. But it’s just for expenses you may have forgotten when setting up that month’s budget.
Zero-based budgets don’t leave money lying around not doing a job or getting lost in the shuffle. And when you use a zero-based budget, you look that extra money in the eye and say, “Come work as hard as I do. I’m going to put you toward paying off debt or saving up for an emergency or good stuff like that.”
Another newly popular budget plan is called the 50/30/20 Rule. This sets all monthly spending and saving into three categories: needs (50%), wants (30%), and savings (20%).
At first, this method seems great—it even gives percentages, which seem official and very financial. But the 50/30/20 Rule leaves only 20% for savings, retirement and debt payoff. That kind of thinking makes for very slow progress toward those money goals.
When you’re using a zero-based method, anything left over after you budget for all your expenses goes toward your current Baby Step. You aren’t stuck at 20%. You can go beyond, which sets you up for faster success.
How to Create a Zero-Based Budget
Making a zero-based budget may sound complicated, but it’s not hard. It just takes some practice. And with EveryDollar, it’s simple:
Add all sources of income.
Type in your fixed expenses like your mortgage or rent, utilities, food and transportation.
Then, type in common monthly expenses such as restaurants, entertainment and clothing. Check your past budgets or bank statements to get an idea of what you typically spend.
Give every dollar a name—meaning all your income has a place in your budget. Remember: This is the key to zero-based budgeting. If there’s still money left after you list all your expenses, put it toward your current Baby Step.
You’ll know you’ve reached zero when you see a green checkmark and the words, “It’s an EveryDollar Budget!”
With an EveryDollar zero-based budget, it’s simple to get your money (every last dollar of it) working for you.
The Purpose of Zero-Based Budgets
Yes, Chris. That’s the intent behind zero-based budgeting! Anything that’s “extra” doesn’t stay “extra.” It’s given a purpose and a job. It doesn’t get spent accidently on coffee runs or convenience-store candy. It doesn’t disappear. It works for you—every last dollar of it.
What You Do With the Extra Money
So, where should you put the “extra” money you find after listing all your income and expenses? What are those Baby Steps we keep talking about? Your first two Baby Steps should be all about creating stability and freedom with your finances. That means you build up your savings and pay down your debt.
1. Build up your savings.
First, you need a starter emergency fund. We call this Baby Step 1: stashing $1,000 in your savings for those unplanned moments. Because one thing you can plan for in life is that unplanned things will happen. Be ready for when life happens with this $1,000, so it can swoop in and save the day like a superhero—without the cape or tights.
Here’s another point that’s important to understand: Even though your budget is based on zero, don’t let your bank account get down to zero. Build a buffer by saving up $50 to $100. This isn’t an emergency fund and it’s not a must-have, but it’s a great tip.
This money doesn’t live in your savings account. It’s a buffer in your checking account so you aren’t left wondering if there’s money there for a purchase when you swipe your debit (not credit) card. Speaking of which . . .
2. Pay down your debt.
Want to gain real control of your money? Stop using someone else’s! Paying off your debt brings new freedom with your money because it puts you in the seat of power over your finances rather than the seat of obligation to your debts. We call this Baby Step 2: paying off all debt (besides your mortgage—that comes later).
Of course, you’ll have other financial goals in life. But starting with these will give you the firm financial foundation you need to budget better and live with less money stress.
And that all starts with a zero-based budget.
You can get started in your EveryDollar budget right now. And if you don’t have one of those, you can change that, too, by signing up.