You work too hard for your money to lose track of it. Adopting a zero-based budget could help you track and effectively use every dollar you earn.
What is a zero-based budget?
A zero-based budget is a framework that assigns a job to every dollar of your take-home pay. In other words, you're aiming for what you bring in and what you send out to hit zero each month. But a zero-based budget doesn't mean your goal is to spend everything you earn.
Ideally, your zero-based budget assigns part of your monthly income to savings goals, like building up emergency savings and saving for retirement. What's important is that nothing just happens to your money by chance. "A zero-based budget is very intentional. There is no unplanned free cash or spending," says Beau Zhao, director of Financial Solutions at Fidelity.
Advantages of zero-based budgeting
You get a better understanding of your financial means
As it makes you focus on how you will spend each dollar you earn in a month, "zero-based budgeting is a great exercise to do as part of your financial planning," says Zhao. Its detailed nature also means that you'll have to decide which discretionary costs you actually care about, and which you can do without.
When reviewing expenses, you might realize, for instance, that you've passively been paying for multiple streaming services or an old subscription you aren't using. You'll also be forced to plan out your indulgences, which can curb impulse spending. You'll decide at the beginning of the month how many meals you will eat out, what entertainment you will purchase, and which clothes you will buy. All of this arms you with the plan you need to avoid stretching yourself—and your wallet—too thin.
You may save more
As you're deciding how you want to allocate your money, be sure to factor in savings. Proactively considering the ways you prepare for today and tomorrow can be extremely helpful, particularly for those who aren't natural savers.
"Usually, people spend first throughout the month and only save whatever is left over, assuming there is anything left at all," says Zhao. "A zero-based budget gets people thinking about how much they'd like to save at the start of the month before they spend their money. It's like paying yourself first!"
You can customize it
Other strategies, like the 50/15/5 rule , set guidelines on the amount that each category of your spending and saving should occupy. According to the 50/15/5 rule, you should allocate around 50% of take-home pay to essential expenses, 15% for retirement savings, and at least 5% for short-term savings. The remaining amount can be used as you wish, for eating out, entertainment, or other savings.
Strategies like this provide a framework that can help you create a plan to save for emergencies and the future. You can even use zero-based budgeting to complement and further flesh out the specifics of a 50/15/5 budget. But if your current financial situation doesn't quite work with those suggested amounts, you may value the customizability of a zero-based budget.
With a zero-based budget, you set the rules and can adapt your plan month to month as your income, needs, and wants change. It's important that when you make these plans you stick to them. Overspending may lead you to drain your savings or even take on debt that you'll then have to allocate even more money to later. And while zero-based budgeting allows for more personalization than other more cookie-cutter budgeting systems, you'll still want to make sure you're working toward saving at least 15% of your income for retirement—that includes any employer match.
Disadvantages of zero-based budgeting
There's a lot of planning
Especially when you're first starting, zero-based budgeting can require a lot of legwork. You've got to figure out your commitments and financial goals and then calculate what amount of your income goes to each. This can become particularly cumbersome if your income or expenses vary significantly month to month, as you may have to make major changes to your budget regularly.
Even with a consistent income, zero-based budgeting can be demanding. Every time you make a purchase, you have to make sure it falls within the guidelines you set at the beginning of the month.
How to make a zero-based budget
Step 1. Start with your monthly income
The zero-based budget begins with identifying your total monthly income. If you don't know what you have coming in, you can't ensure you aren't overspending.
If you're on a fixed salary, you can easily find your monthly take-home pay by checking your paystubs or your bank account direct deposits to see how much you receive after-tax each month. Be sure to include any other income you may have, like from gig work, and keep in mind that some of your money may already be going to retirement savings through workplace retirement plans like a 401(k).
If your income changes each month, zero-based budgeting is a little trickier. Look over the past year of your monthly earnings and identify your lowest grossing months. You may want to use these to plan from to ensure you don't overspend. Then, for months that you do earn more, you can funnel extra funds to savings, debt repayment, or more discretionary expenses; you might also choose to earmark that money for a future month's expenses or savings.
Step 2. List your expected spending and saving
Next, make a list of everything you think you'll spend for the upcoming month. If you aren't already aware of these expenses, look over your previous months' credit card and bank statements to see where your money went. You'll want to note which of these charges are essential—think: housing, groceries, medical costs, debt repayments—and which are nice-to-haves. It may be helpful to break your needs and wants into subcategories, like entertainment, travel, and personal care, so you can better keep track of how much you plan to spend on what.
Set a target amount you want to spend in each category or subcategory. You should also list how much you aim to save for the month, both in your retirement accounts and your nonretirement savings.
Step 3. Subtract your expenses and saving target from your income
Finally, take your spending and saving targets and subtract them from your monthly income. You should wind up with exactly zero.
If you come up with a negative number, you're planning to spend more than your means. This is when you'll want to review those nonessential costs you identified earlier and see what can go. Otherwise, you'll have to tap into your savings—or go into debt—to cover your spending. Over the long term, consistently overspending can derail your financial health.
If you end up with a positive number, congrats. You've got extra money unaccounted for. Check to see that you're providing enough for emergency savings, retirement, and other short-term savings goals. And if so, you can plan to spend that money on anything you choose.
Step 4. Track your results and compare
Zero-based budgeting lays out your plan for the month. But real life might have other ideas. Even when you stick exactly to your plan, not every expense is predictable, which is part of what makes having emergency savings so important.
Luckily, zero-based budgeting requires you to revisit and revise your financial plans often. As you prepare your next month's budget, compare your spending for this month with your plans for the next. If something was off, ask yourself: Is this something that I truly couldn't have foreseen, like an emergency, or something I should account for going forward? If it's the latter, adjust for next month.
If the budget mismatch arose due to overspending in a category, you could consider trying out the cash envelope system. That's when you go to the ATM and take out enough cash to cover all of your expenses and portion it out in labeled envelopes. Once you've spent all the cash for a certain category, you're forced to stop spending.
Is zero-based budgeting right for you?
"Zero-based budgeting is a great exercise for figuring out your spending versus your take-home pay," says Zhao, even if you end up transitioning to another budgeting framework once you've got a handle on this. It can be especially helpful for those whose financial situation has changed recently.
"For example, rising inflation has changed the way we spend in many ways," he says. "Zero-based budgeting can help them figure out how to balance increased cost of living with income."
Overall, those with regular, reliable income, like a fixed salary, will find it easiest to manage a zero-based budget each month. But those with less predictable, variable incomes can benefit as well, even if figuring out every dollar you have coming in may be more challenging.
Ultimately, the best budget for you is the one that keeps you making progress on your financial goals and that you can stick to.