How would you like a budget that lets you spend every single dollar you have? That’s exactly how the zero-based budget operates, and it’s increasingly popular as a tool to help people save more and spend less.
The concept of zero-based budgeting has actually been around for several decades. It was developed in the 1970s by Peter A. Pyhrr, who worked as a manager at calculator-maker Texas Instruments in Dallas, Texas. At the time, the budgeting method caught on as a popular way for businesses to budget but eventually went out of fashion.
Today, zero-based budgeting is having something of a renaissance, not as a business accounting tool but for helping people manage their personal finances.
How Zero-based Budgeting Works
The goal of zero-based budgeting is to ensure you don’t spend any money that you don’t have to spend. The method gives you an opportunity to review each dollar in your budget and assign amounts to spending categories so that you can get a picture of where your money goes each month.
“There should never be any money ‘left over’ because a zero-based budget includes expenses such as ‘investments’ and ‘savings’,” says Scottsdale, Ariz.-based Certified Financial Planner Alexander Koury.
The goal is simple: income - spending = 0
How to Follow a Zero-based Budget
List all of your net monthly income
To kick off your zero-based budget, figure out exactly how many after-tax dollars you have coming in every month (you could track your earnings biweekly, as well).
If you’re a salaried worker with a steady income, it’s fairly simply to predict your earnings. If you do contract work or your income is irregular, you may want to average your income for the past three months to create a starting point, then adjust it accordingly.
List all of your sources of income to get your total income for the budgeting period. That number will be your starting point.
Track your past spending
A benefit of the zero-sum budget is that it “helps create awareness of all outflows and expenses,” says San Francisco-based financial planner Catherine Hawley.
In short, you’ve got to know where your money is disappearing to every month.
When you become fully aware of where all of your money goes, you can discover where you’ll need to control your spending.
Start by listing all of your fixed expenses for each period. Those are expenses that you know you will need to make each period. For example, in a monthly budget you may have rent, utilities, and subscription services listed as your fixed expenses.
Next figure out where you spend your flexible dollars. Try an app like Mint to easily categorize your expenses. Or do it the old-fashioned way with a spreadsheet or pen and paper. Koury recommends pulling your past 12 months of expenses to locate and categorize your purchases.
Create your budget
Once you have your income and expenses calculated, it’s time to throw it all together and zero out your budget.
“Budgeting is the foundation on which financial planning is built. Without having a budget, it is difficult if not impossible to grow and create wealth,” says Koury.
Take your income for the budgeting period and subtract your fixed expenses. Hopefully, you’ll still have money to play with, because next you’ll need to decide how much you want to “spend” on savings and long-term goals like retirement.
“When you list out your expenses, put yourself at the top of the expense list. You are the most important, and you always want to pay yourself first,” says Koury.
Fixed expenses and savings (paying yourself) should always come first on your budget. If you still have money left over, don’t let it sit in your account without a purpose. With a zero-sum budget, every dollar you earn should have a job. Otherwise, it’s easy to lose track of those dollars. Go back to the beginning, when you listed out your spending categories. A trend probably emerged, showing you where you spend the most. Maybe it’s eating out with friends, or buying toys for the kids. Designate a certain amount you’re allowed to spend out of your total budget to those categories. Once you set a limit for spending there, you’re less likely to go overboard.
If you get paid bimonthly or biweekly, you may want to create two versions of a budget — one for the first half of the month and another for the second half of the month to accommodate for bills for fixed expenses due at different times in the month.
Pros and Cons of Zero-based Budgeting
Pro: You know where your money is going.
The best part about a zero-based budget is that you’ll know exactly what you are spending your hard-earned money on. At first, your spending habits may surprise you. You may be shocked that you spent more on dining out than on groceries last night, or that your shopping habit has gone a bit overboard.
“The main reason people use zero-based budgeting is to control their spending habits in the face of impulsive behavior,” says Dr. Constantine Yannelis, an assistant professor of finance at NYU Leonard N. Stern School of Business.
When every dollar you earn is assigned to a task, you are able to visualize and rationalize your budget each period. You can see how cutting back in certain spending categories will help you to reach your financial goals.
Con: A zero balance requires a lot of discipline.
If this is your first attempt at budgeting, you may want to ease into it, as it requires you to be very disciplined.
“[The budget] may become too strict, just like a diet, and if one gets off track even for a bit, they may stray from using it and they may go back to their old ways,” warns Koury.
Unfortunately, the budget that creates a place for every dollar doesn’t leave much room for error.
“The chief pitfall of zero-sum budgeting is that it can decrease flexibility, and if adhered to strictly, it can lead to artificial constraints on what individuals may purchase,” says Hawley.
Don’t be too hard on yourself. It may take a couple of budget cycles for you to get used to your new budget and to adapt it to your lifestyle.
Pro: If you stick to it, you’ll see results.
This budget is not for the commitment-phobic. The zero-balance budget is an exercise.
“It is a very results-based approach to creating great results,” says Koury. “The more disciplined you are in your approach, the more effective the results can be. If you have specific goals, then you would want to use this approach.”
Dr. Yannelis says the zero-balance method is also good for new budgeters because “it provides a commitment device for individuals with difficulty meeting their spending and savings objectives.”
Con: This may not work well for emergencies.
The zero-balanced budget is pretty strict, so “it may not work well if people have unpredictable spending needs due to health issues, children, or other life events,” says Dr. Yannelis.
To combat this, you’ll want to make sure to contribute to an emergency fund each period and to make sure you have insurance coverage for all of the important things — health care, disability, life, home, auto, etc. You can’t predict when an emergency will cost you financially, but it’s better to have cash stashed so a small emergency with the kids won’t interrupt your budgeting goals.
Pro: You can track progress toward your goals.
Using this budget — especially when you use it with a budget-tracking tool— can help you see the progress you are making toward your savings and debt repayment goals. If you can stick to the contribution you make each month, you can more easily predict when you will reach your goals.
Mark that date, and stay as close to your budget as possible to reach your goal by it. If you happen not to spend all of your money in a particular category, it has to go somewhere. You can contribute the extra funds to your savings or debt payment goals to beat your target date.
Con: You may be “overdoing” your needs.
The zero-balanced method can get very detailed since you need to track the route of each and every penny.
“It can be more detail than some people need. For some it’s enough to carve out long-term savings and live off the rest,” says Hawley.
Koury says the method works better “for those that are diligent about their finances and are analytical.”
If you make more than enough money, you might not care or feel the need to make a super-detailed budget.
“Some people just like knowing they put a certain amount of money in their savings account monthly, and they spend the rest,” says Koury.
Tools to Help You Master Your Zero Balance
EveryDollar and EveryDollar Plus
EveryDollar is a budgeting app created by personal finance guru Dave Ramsey, who popularized the zero-based budget for personal use. You can use it on your desktop or smartphone.
The app automatically creates eight spending categories that cover the basics of most budgets, but you can create budget-specific custom categories, too. It also lets you set up “funds,” which are saving accounts. This lets you set aside money for an emergency fund or other savings goal. The app also sends you tons of reminders to stay on top of your goals.
In addition to the basic version of EveryDollar, there is a premium version called EveryDollar Plus that can be connected with your bank account to pull in your transactions automatically.
You Need a Budget (YNAB)
You Need a Budget — aka YNAB — is budgeting software that’s also available for desktop and mobile devices. The company’s mantra, “Give every dollar a job,” describes its zero-balance foundation.
It prompts you to assign the money you have to a budget category. When you have one month’s worth of expenses fully funded, you can start budgeting funds for future months.
YNAB will cost some money to use. The platform offers a 34-day free trial, after which you will have to pay either $5 a month or $50 a year. Students can get 12 months of YNAB budgeting for free, after which they’ll be eligible for a 10% discount for one year.
MagnifyMoney is a price comparison and financial education website, founded by former bankers who use their knowledge of how the system works to help you save money.