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Updated: Sep 06, 2023

What is a Zero-Based Budget?

Learn about zero-based budgeting and how it helps you save money and also pay down debt. See the step-by-step process to building this budget for your finances.
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Creating a budget is one of the best things you can do for your financial health.

Not only does a budget help you take charge of where your money goes, but it also helps you set a clear path toward your financial goals.

Zero-based budgeting is just one of many budgeting methods, but it’s one of the most effective. The goal is to match your expenses to your income exactly.

In other words, you give a job to every dollar you earn. This process allows you to be intentional about your money management.

How to Build a Zero-Based Budget

The formula is simple: Income minus expenses equals zero.

But getting there can be difficult, so here’s a 5-step guide to establishing and maintaining a zero-based budget.

Step 1: Determine your income

Creating a zero-based budget is easy if you have a set salary every month. If you know that you’re going to take home $4,000 after taxes no matter what, this step will be easy.

If, however, your income is irregular — say, you sometimes work overtime, or you own a business — it can take a little more effort.

One way to do it is to create your budget immediately after you get paid. This way, you already know how much you have to work with.

If you get paid weekly, set your budget for the next week. If you get paid biweekly or semi-monthly, do the same for those periods.

If you want to create your budget just once a month in the beginning, however, you’ll need to do some forecasting.

Start by going back 3 to 6 months — the longer you go back, the more accurate your forecast will be — and average how much you earned during those months.

Also, if you have an idea of how much you’ll make this month based on planned overtime or business income, take that into consideration too.

As you determine your final number, be conservative but don’t give yourself so much of a buffer to defeat the purpose of a zero-based budget.

Step 2: Set aside cash for savings and extra debt payments

Paying yourself first is one of the best things you can do for your financial goals.

If you wait until the end of the month to save whatever is left over, you’ll be more tempted throughout the month to spend this surplus instead of saving it.

In other words, consider savings and extra debt payments as an expense.

That way, it’ll be easier not only to save money for emergencies or other short- or long-term needs but also to put more toward your debts each month beyond the minimum payment.

Write down your goals and make them realistic. The last thing you want is to have to adjust them down after the next step.

Step 3: Determine your expenses

This process can take a while, especially if you’ve never budgeted before.

Because your goal is to match your expenses to your income exactly, you’ll need to consider every single type of expense you’ll have.

One way to simplify this process is to separate them into fixed and variable expenses.

Fixed expenses aren’t all necessary, but they likely won’t change from month to month, including:

  • Rent or mortgage payment
  • Insurance premiums
  • Internet
  • Debt payments
  • Phone
  • Cable

Next, consider your variable expenses, which can change from month to month. Some examples include:

  • Utilities
  • Groceries
  • Eating out
  • Entertainment
  • Clothing
  • Toiletries and household items
  • Medical
  • Miscellaneous

Since these are variable, you’ll need to estimate a lot of them. One way to do this is to look at how much you spent in each category for the last month or two.

And with utilities, you’ll typically get a bill long before it’s due, so you may be able to look it up.

As you try to determine your variable expenses, give yourself a buffer by estimating a little higher on each.

That way, if something comes up and you spend more on doctor’s office copays than you anticipated, you could take a little cash from some of your other expense categories to avoid going into the negative.

Step 4: Balance your budget

Now, you’ve got your income number and your expense numbers, but you haven’t balanced them out yet. Take the time now to do so.

Take your monthly income amount and subtract all of your expenses, including savings and extra debt payments.

If your end number is negative, you’ll need to cut some expenses to bring it to zero.

Start by looking at your variable expenses, then consider whether you need to lower the amount going toward savings and extra debt payments.

Remember, the goal of budgeting is to prioritize your financial goals, so don’t cut back on savings and debt payments unless you have to.

If your end balance is positive, that means you have extra money to allocate somewhere.

The best course of action is to put this money to good use by saving it for adding it to your debt payments. But you can also set a little aside for some splurge spending; the key is to be reasonable.

Step 5: Make adjustments as necessary

If you’re new to zero-based budgeting, it can take a few months to get the hang of it. So, don’t give up if it doesn’t work the first month or two.

As you make mistakes and your spending habits change, tweak your budget to improve your approach.

4 Tips for Making a Zero-Based Budget Work

Creating a zero-based budget takes time, and it can do more harm than good if you don’t do it right.

To help you make the most of your zero-based budget, here are a few tips.

1. Keep a buffer in your checking account

While you want to match your expenses to your income so that the difference is zero, that doesn’t mean you want $0 in your checking account at the end of the month.

Life is unpredictable sometimes, and if you end up overspending, you could overdraw your account.

So, keep a small buffer in your checking account — between $100 and $500, or whatever makes you feel comfortable — to avoid getting slapped with an overdraft fee.

2. Build up an emergency fund

While things can come up that can throw off your budget, it’s important not to let real emergencies do that to you.

A broken-down car, a burst water heater, or a short-term job loss can wreak havoc on your finances.

To give you an even wider safety net, work on building an emergency fund as quickly as possible. It’s wise to start out with $1,000 to $2,000, but over time work to build that up to three to six months’ worth of your basic expenses.

With an emergency fund, you’ll sleep better at night knowing you’re protected from major unexpected expenses.

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3. Prioritize and automate your savings

To make it easier to pay yourself first, set up automatic transfers from your checking to your savings account.

Be sure to time the transfers, so they come on payday or shortly afterward to avoid overdrawing your account.

While you’re at it, consider opening more than one savings account so that you have an account for each goal, such as an emergency fund, holiday gifts, vacation, home improvement, and more.

By doing this, you’ll have a clearer sense of where you are with each of your goals.

Additionally, open an individual retirement account (IRA), even if you have a 401(k) or similar employer-sponsored retirement account.

While 401(k) contributions will happen before you get your paycheck, you’d need to fit IRA savings into your budget.

4. Have a plan for your debt payoff

If you’re setting aside money each month to make extra debt payments, it’s essential to have a strategy.

For example, do you want to tackle the debt with the lowest balance first or the highest interest rate?

There’s no right answer to that question. Tackling the debts with the highest interest rates will save you more in interest, but paying off lower balances first can give you small wins to keep you motivated.

Either way, consider both options and choose which one is best for you.

The Bottom Line

A zero-based budget is one of the best ways to manage your money. By assigning every dollar a purpose, you’re more in control over how you spend or save your money.

That said, budgeting this way takes time and effort. In addition to setting your monthly budget, you need to track your spending to make sure it stays in line with your goals. You can do this with pen and paper, a spreadsheet, or a budgeting app.

The important thing is that you find what works best for you and stick with it. Over time, budgeting will become almost second nature, and you’ll be on a better path to reaching your financial goals.