Your Quick Guide To The Zero-Based Budgeting Method

Using a budgeting method is a popular, effective way to reach your financial goals. Whether you’re planning to buy a home, set up an emergency fund or make another decision involving money, setting a budget can be a big help.

Many budgeting templates and methods are available, so evaluating a few is a smart first step. For now, let’s focus on the zero-based budgeting – or ZBB – method.

Then, we’ll explore some alternatives.

What Is Zero-Based Budgeting (ZBB)?

The ZBB type of budget determines a category for every dollar of your monthly income. Funds from your entire paycheck go into a particular category for all your planned expenditures and savings.

Though companies and government agencies often use the ZBB method, its principles can also apply to families and individuals.

How The Zero-Based Budgeting Process Works

To use ZBB, you’ll need to analyze your income, spending and financial goals. Let’s break it down, step by step.

1. Determine Your Take-Home Pay

Calculate how much money you make after taxes and other deductions. This is also called your net income.

2. Calculate Your Expenses

Determine how much you spend and on what you spend it. You can think in terms of living expenses, debts, savings and financial goals to establish a baseline. We’ll discuss some potential categories shortly.

3. Establish Your Personal Goals

This is a good time to determine personal finance goals. If you’re saving for a down payment on a house, consider opening a separate savings account. You can also allocate money to short-term financial goals.

4. Allocate All Of Your Funds To The Categories You Select

Earmark money to go into the categories you’ve determined. You can set a certain percentage to go into your checking, savings, retirement and emergency fund accounts, for example.

You can make this easier by automating your finances using a solution such as the Rocket Money^SM app. This automatically deposits percentages of funds from your paycheck to the right accounts.

5. Monitor, Evaluate And Modify Your Budget Allocations

Check your bank accounts regularly. If you don’t see the savings growth you hoped for and you don’t spend all your discretionary income, you can designate more money to go into your savings account. Likewise, you can reallocate some of your savings percentage to your living expenses if your rent increases or the cost of groceries goes up.

You can also re-think your allocations if you get a raise.

Categories For ZBB

Let’s revisit the spending categories concept. Living expenses and debt repayment should be the primary drivers of a zero-based budget. Once you’ve determined these amounts, many financial experts would urge you to consider savings. Finally, you’ll have discretionary income.

Here are a few ideas for broad categories – along with suggestions for subcategories – to get you started.

Living Expenses

Living expenses include all your necessities, which are the items you can’t cut out of your budget. Common examples of living expenses include:

• Groceries/food
• Housing
• Health care
• Transportation
• Clothing

Debts

If you owe money to creditors, it’s important to pay down this debt. Many people have debt in the form of:

• Credit cards
• Personal loans
• Student loans

Savings

It’s smart to save for both the distant future and short-term endeavors. Here are a few  categories of savings:

• Retirement
• Emergency fund
• Education fund
• Vacation fund
• Home renovation fund

Discretionary Spending

Life is more than work, right? Here are some common examples of discretionary spending:

• Entertainment
• Hobbies
• Streaming subscriptions

Zero-Based Budgeting Example

Here’s what a zero-based budget might look like for a household with a net monthly income of $5,000.

Pros And Cons Of Zero-Based Budgeting

Like any method, zero-based budgeting has its strengths and weaknesses. Let’s review a few examples of both so you’ll be more equipped to decide if ZBB is the right choice for you.

Advantages Of Zero-Based Budgeting

Among other benefits that ZBB can offer, this method:

• Zeroes in on overspending: Since you’re accounting for every dollar of income, ZBB will show where you might spend too much.
• Shows where to adjust: You might notice how your discretionary spending compares to your living expense – and whether spending too much on entertainment is making it hard to pay your housing expenses. You can also adjust according to changes in living expenses or income.
• Allows you to set realistic percentages: Some budgeting methods suggest using their set percentages for spending categories. In some cases, those percentages might not be realistic, especially when inflation is high. ZBB puts the decisions in your hands based on your specific situation.

Disadvantages Of Zero-Based Budgeting

Among other downsides of ZBB, this method:

• Might not be best for beginning budgeters: Determining your categories may require a deep dive into your expenses. This can overwhelm people new to budgeting.
• May be too flexible: ZBB allows you to get hyper-specific with categories. This can be great for some people, but others might get bogged down in all the possibilities.
• Can be time-consuming: This goes back to the categories: If your income or economic conditions change, you’ll have more categories to tweak. This can also be challenging in the first few months as you evaluate progress toward the goals you set.

Alternatives To The Zero-Based Budgeting Approach

As noted already, ZBB is just one of many models for personal budgeting. Next up are some alternative methods that work for many families and individuals.

The 50/30/20 Budget

The 50/30/20 budget is a solid start for beginning budgeters because it has relatively few categories. This makes it easy to figure out where your income should go. In a nutshell:

• 50% of your net income is for needs (housing, transit, groceries, etc.)
• 30% is for “wants” (recreation, dining out, gym membership, etc.)
• 20% is for savings and, in some cases, debt repayment

If your area has a high cost of living, you can adjust the percentages to better suit your situation. For example, if you live in New York, you might need to bump up your “Needs” category to 60%.

The 80/20 Rule

This system prioritizes your savings goals, with 20% of your net income going straight into savings accounts. The rest goes into one other broad category, with no distinction between living expenses, debt payments and discretionary spending. While it’s simple and easy to follow, the 80/20 rule might not help you identify overspending or pay down debt.

The Cash-Stuffing Method

With the cash-stuffing (or envelope budgeting) method, you’ll put – or “stuff” – your take-home pay into envelopes. These can be literal envelopes, separate bank accounts or digital envelopes in a budgeting app. The envelopes correspond to spending categories that you determine (similar to the zero-based system).

Once you run out of money, you don’t have any more to spend for the rest of the month. If you have any funds left over, they’ll go into your savings accounts.

The Bottom Line: ZBB Is Flexible And Can Be Worth The Effort

Zero-based budgeting can help you identify unnecessary spending, save for major expenses and ensure that you’re able to pay your bills and debts each month. The number of potential categories can be challenging, so ZBB requires some maintenance and discipline. But it can be worth the effort if it helps you reach your financial goals.

Remember, though, that the best budget for you is one you’ll stick to and update, as needed.