Over the past few months, I’ve been writing about some of the most popular personal finance apps, and two that I’ve covered – EveryDollar and YNAB – build their platforms around zero-based budgeting. Both of these apps are incredibly successful, and I’ve heard many YNAB customers affirm that budgeting like this has been life-changing.
Since I’m not a zero-based budget-er, I wanted to see what’s so great about this system. Will these apps work for everyone? And, how does one prepare a zero-based budget?
So, what is zero-based budgeting?
The concept of zero-based budgeting is pretty simple: you take the amount that you earn each month and then allocate money for different budget categories until there’s nothing left, or you “zero out.” You may see it abbreviated as ZBB or called zero-sum budgeting, and all of these terms work on the principle of giving every cent a purpose.
It’s also similar to the envelope system – setting a certain amount of cash aside for budgeting categories and only using what’s in those envelopes for each line item. The thought process is similar because it forces you to only use the money you are actually earning so you aren’t relying on credit cards.
Really, the purpose of zero-based budgeting is that it allows you to find room in your budget for things you may have thought to be out of reach, like investing, paying down your debt, etc. It’s making room for your financial goals instead of just hoping you can fund them at the end of the month.
Zero-based budgeting is such a valuable tool that many large corporations and businesses even use this approach on a much larger scale to improve their cost efficiency.
You’ve probably already heard about zero-based budgeting
Dave Ramsey is a big proponent of zero-based budgeting because he is against the widespread reliance on credit cards, and zero-based budgeting is a core belief that he’s instilled in his financial advice. While you may not agree with everything he says, I think that we can all agree that being lazy with your savings goals and debt pay off rarely leads to a positive outcome.
Ramsey even built his personal finance app EveryDollar around this principle, and YNAB uses the same approach. YNAB is advertised as “giving every dollar a job,” which pretty much sums up the goal of zero-based budgeting.
But, does zero-based budgeting actually work?
You’ll never find me telling someone that one budgeting approach works better than another because personal finance is personal. We each go in with different mindsets and habits to overcome, so it’s really hard to say that one works better than another.
But, I will say that zero-based budgeting teaches you a valuable personal finance lesson – if you want to make your goals happen, you must be proactive.
Here’s an example of what I mean by that:
Say you have a monthly student loan payment of $400, but you’d like to put an extra $200 towards your payment to reduce the life of your loans and save money. While you know what an extra $200 a month will do, you continue spending as you normally would hope to have that extra sitting in your bank account at the end of the month. If you’re like a lot of people, that $200 won’t be around at the end of the month.
With zero-based budgeting, you set your student loan budget for $600 and adjust the rest of your expenses to make that payment happen. That might mean you need to cut your $100 a month cable bill, $50 a month for going out to eat, and an additional $50 that you might spend on clothes. Zero-based budgeting shows you that a $600 a month student loan payment is possible.
Easier said than done, I know.
But, when you actually see that your budget does allow for your financial goals, you’re more likely to make them happen. You’ll have to actively adjust your spending habits, and if you need to find ways to increase your income, you’ll see what you need to do to make those goals a reality.
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How to start zero-based budgeting
If zero based budgeting sounds like something that will work for you, here are some guidelines to help you get started:
1. Know how much you make
Any good budget starts with knowing what’s actually coming in each month. You don’t want to guess this number at random either – get to know it and know it well.
2. Track your expenses
You’re going to want to start tracking EVERY SINGLE THING you spend money on each month to make a clear and realistic budget, again no guessing. This is key to zero based budgeting. You could write everything down the old-fashioned way with pen and paper, use financial software (like Mint), or closely check your debit and credit card statements. It can take a few months to get a real sense for what your budget looks like, and you’ll want to account for any irregular spending, such as vacations, holidays, and semi annual or annual payments.
As each expense comes in, it is useful to categorize them as well. Going out to eat could be categorized as “entertainment” whereas gas might be “transportation” in your zero based budgeting plan. Taking the time to categorize each expense from the get-go will be especially helpful to those who have fluctuating incomes, like freelancers.
3. Make a list of all of your monthly and non-monthly expenses
Now that you’ve been tracking them, this will be so much easier. Here’s a list of monthly expenses you may have:
- Car insurance
- Health insurance (or payments to a health care sharing ministry)
- Cell phone plan
- Extras – these can be lumped together or separated, but they include gym memberships, streaming services, etc.
In addition to recurring monthly expenses, you may have some non-monthly or seasonal expenses you’ll also want to account for in your zero based budgeting plan. While you aren’t spending that money each month, you should be putting money aside so you know that you can cover these costs when they do come in. These will be things like:
- License plate renewal
- Property taxes
- Holiday spending
- Renewing yearly membership plans (think Amazon Prime)
4. Make a list of your savings goals and debt reduction goals
This is really where zero-based budgeting shines and why it’s so popular with people who are working towards big financial goals… which you should be setting and working towards. You can set up financial targets like putting $400 a month towards your IRA or $600 a month towards student loan payments.
This is also a place that you would list goals like going on a vacation. If that means having $2500 set aside to visit the Bahamas over the winter, you’ll want to know your timeline and how much you’ll need to save each month to make that happen.
5. Start doing the math by subtracting your expenses out until your budget zeros out
If you like to nerd out on math, then this might be the best part of zero-based budgeting, but for others, this might feel like an overly complicated puzzle.
You’ll be taking your monthly income and subtracting each line item out to arrive at zero. If you get to zero before you’ve allocated money to each of your budgeting items, then you’ll need to move things around a bit to make your zero-based budgeting plan work. This will also be where you see whether or not you need to start earning more to make those goals happen. You know I love side hustling to earn more.
If you’re feeling stressed out during this process, just keep your eyes on the prize – you’re working on your now to build a better financial future.
6. Start using your budget
I often see this step left out of articles about “how to zero-based budget,” but it’s probably the most important one. Personal finance tools like EveryDollar and YNAB can help you with the day-to-day upkeep of your budget, but you’ll want to get comfortable with continuing to track your spending.
If you know you only have $400 to spend at the grocery store each month, break that down into smaller increments, like $100 a week. If you find that you’re going to go over that amount, then cut the amount you’re spending on going out to eat.
7. Keep track of how you’re doing
Zero-based budgeting isn’t an infallible system, so you’ll want to track your progress to identify where you’re meeting your targets and where you’re struggling. It’s also 100% okay to move things around as you go. The more you use zero-based budgeting, the more efficient you become.
You might realize that you’re consistently spending $20 less a month on gas… maybe you’re taking a new route to work that cuts your fuel costs. You can put that $20 to an area that you’re struggling to fully fund.
Pros and cons of zero-based budgeting
With any new system you implement, there are going to be some factors that are going to determine how successful you are. To help you understand how this method might be useful and where it might fall short, the following are a few pros and cons of zero-based budgeting.
- You’re taking an active role in your finances. Anytime you do your budget, you’re making strides to build a better financial present and future, and you’re learning new tricks, creating new habits, and getting better as you go. While a passive strategy is good for investing, taking an active role is often best for budgeting.
- Zero-based budgeting is flexible. There seems to be this myth that budgeting is too rigid for the average person, but I don’t think that’s actually the case. You may have to adapt as you go, but that’s just getting to know your spending habits and making adjustments as needed.
- It helps you prioritize your goals. Zero-based budgeting is all about finding money in your budget to realize your goals, making it a very powerful tool if you want to get out of debt, start investing or work towards retirement.
- It can be difficult to utilize zero-based budgeting if you have an irregular budget. For freelancers or those working jobs with fluctuating income, it’s hard to know exactly what you’ll have to spend each month. To ease that stress, you’ll need to categorize expenses and focus on the most important ones first. When you have more income coming in, you can start taking care of the rest of your expenses.
- Zero-based budgeting can be time-consuming. Because it requires tracking your expenses, this system can eat up a lot of your time. While that might be a huge turn off for some, focusing on the outcomes can motivate you to make it all happen.
Need help with zero-based budgeting?
Like I’ve already mentioned, there are a couple of apps that I’ve reviewed on M$M that can help you build and implement a zero-based budget that works for you. EveryDollar and YNAB are some of my readers' favorites, but if you have other apps or tools you love, let me know in the comments.