What is a Zero-Based Budget? | CapWay
- Zero-based budgeting is a structured approach to managing your money.
- The goal of the zero-based budget is to achieve a zero balance each month by spending, saving, and investing with your paycheck.
- Zero-based budgeting is a stepping stone to saving for more significant financial goals.
If you find yourself routinely having more month than money, it may be time to embrace a more structured budgeting approach with a zero-based budget (ZBB). Zero-based budgeting, as the name implies, leaves little room for guesswork, providing practical steps for managing your money.
What is a Zero-Based Budget?
Zero-based budgeting aims to spend, save, make debt payments, and invest all the money you earn to the last penny. This is achieved through careful budgeting, tracking your expenditures, and allocating budget surpluses to pre-determined categories like spending or investing.
Below is a deep dive into the zero-based budget method and how it works.
The ABCs of ZBB
The primary difference between a typical budget and a zero-based budget is that conventional budgets don’t specifically allocate leftover money in your checking account for a subsequent task. However, a zero-based budget assigns those funds to a goal you’ve identified ahead of time, for instance, paying off a credit card or increasing your investments in a stock or bond portfolio.
Though it may sound like the goal of zero-based budgeting is to let the good times roll and spend every cent of your paycheck, the approach is more nuanced than that and seeks to give each dollar a specific purpose.
Some dollars will have the job of paying for the roof over your head—your rent or mortgage payment. Other dollars must ensure that you are fed and cared for (think food, clothing, and medical expenses). As such, the first step in developing a zero-based budget is understanding the timing and types of your various expenditures and income streams.
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Breaking Down Your Income and Expenses
Taking out a blank sheet of paper and developing a budget from scratch can feel daunting, with your mind drawing blanks on where exactly your hard-earned cash goes each month. One surefire cheat is assembling your credit card statements, stock or other investment account statements, bank statements, pay stubs, and invoices from gig work.
Many credit card companies automatically group your monthly expenses by categories such as automobile, food, clothing, health, and travel. In addition, some banks like CapWay have also opted to categorize their account holder's expenses. This paper trail can help you better understand where your money is going each month and on which expenses they are being spent.
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How to Create Your Zero-Based Budget
List Your Income and Expenses
Once you’ve analyzed your income and expenditures, you can begin listing your various spending and income types. For example, the list might include the following:
- Housing. For instance, rent, mortgage payments, routine maintenance, property insurance.
- Transportation. Car note, gas, scheduled maintenance.
- Debt. Student loans, credit cards, personal loans.
- Savings. Emergency fund, holiday, or vacation savings.
- Investments. Retirement account, personal investment goals.
- Groceries. Note that restaurant expenses should be grouped under entertainment.
- Utilities. Water, gas, electric.
- Health insurance and medical expenses.
- Family Care. Childcare, elder care, and other family care expenses.
- Entertainment. Vacation, restaurant (dining out), movies.
- Subscriptions and Memberships. Gym, internet, cable, and streaming services.
- Personal Care. Hair, nails, day spa, and other required self-care.
- Pets. Pet food, pet vaccinations, daycare.
- Giving. Charity, gifts, tithes.
Identify Your Money Goals
In addition to your living expenses and investment contributions, you’ll create categories for your financial goals. Initially, you’ll want to keep it simple. While you may have several financial objectives, like paying off your student loans or investing in real estate, you’ll get the most traction by identifying and starting with only two or three items.
Once you've identified your money goals, decide how much monthly surplus you want to allocate to each category. For instance, if your two categories are student loan debt and stock investing, determine if you want to allocate 50% to each or if you’d prefer a heavier weighting, for instance, 70% to stock investing and 30% to additional payment towards your student loan.
Finally, let’s put our newfound knowledge into practice with an illustrative zero-based budget:
Zero-Based Budget Example
In this example, we will assume that your after-tax income, which is actually deposited into your checking account after Uncle Sam gets his cut, is $3,000 a month.
Further, we'll assume that your monthly spending breaks out as follows:
- Rent: $1,000
- Utilities (Gas and Electric): $150
- Groceries: $200
- Cell phone bill: $50
- Car note: $200
- Car insurance plus gas: $100
- Cable bill and internet: $100
- Medical insurance premium and deductible payments: $100
- Entertainment/fun money: $150
- Retirement fund contribution: $100
- Emergency savings contribution: $50
- Student loans: $200
- Credit card bills: $200
- Savings: $200
- Additional payments towards credit card balance: $200
After paying all your monthly expenses, including savings, investment contributions, and debt payments, you have allocated a total of $3,000, which means you are left with $0. Every penny is accounted for! While a budget that has a goal of zero may feel unnerving at first, that is precisely the point of a zero-based budget.
Under a zero-based budget, flexibility is already built in for fun activities like going out to eat, as well as contributions towards “stretch goals” like paying off a credit card early. This built-in planning helps make a zero-based budget more resilient than most budgets, allowing you to bounce back from unexpected challenges (hence, your emergency fund line item) and enjoy an unplanned night out on the town (through your entertainment/fun line item).
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The Good, Bad, and Ugly of Zero-Based Budgeting
The Pros
A significant advantage of zero-based budgeting is that it allows you to face, squarely and monthly, what you’re making and spending. In addition, doing this routinely will build a reflexive knowledge and intimacy with where you stand with your finances.
A second advantage is the discipline and fortitude required to get your finances on track. Doing so will instill a sense of pride, achievement, and can-do spirit when facing other financial goals, such as saving for a house or raising your credit score.
The Cons
A drawback of the ZBB approach is that the to-the-penny monthly tracking process is labor-intensive and time-consuming. Particularly if you’re a big-thinker type who enjoys coming up with business ideas, strategizing, and planning for the future, the nose-to-the-grindstone approach of ZBB may be tough to commit to long term.
An additional challenge is that if hard-to-plan but important expenses arise during the first few months of implementing ZBB, for instance, a wedding or a broken laptop, you might be tempted to quit or blame ZBB when the inevitable negative income results. The better path is to hang in there and, over the next several months, gradually begin layering in a savings line items for these potential expenses.
The Money Wrap-Up
One way to maximize your financial potential is by becoming familiar with the rhythm and flow of your expenses and putting your money to work for you. Whether you make six figures a year, minimum wage, or something in between, every dollar you earn is an opportunity to make more.
A zero-based budget can provide you with the tools and roadmap to take your first steps towards truly managing your money, no matter what your money goals are or where you are in your personal finance journey.