What Is Zero-Based Budgeting and How Does It Work?

When your paycheck hits, do you put every dollar to use? If not—and you have money sitting idly in your checking account—you may want to consider zero-based budgeting. Also called zero-sum budgeting, this method entails giving every single cent of your take-home pay a job.

While this budgeting strategy may be a bit more time consuming than others, it can help you reach long- or short-term financial goals such as securing a comfortable retirement, buying a home or going on vacation, all while you pay for routine essentials.

How does zero-based budgeting work?

Zero-based budgeting requires allocating every dollar of your income to a specific purpose. First you’ll cover your basic needs, such as housing, utilities, and groceries. But once you subtract those expenses from your income every month, you can start to give your remaining dollars another job: paying off debt, building your emergency fund, investing for the future, or just covering dinners out and movie tickets.

Like most budgeting strategies, the best way to use zero-based budgeting is to tweak it for your specific needs. If you don’t have student debt, you won’t include that line item in your plan. Instead, maybe you designate that money to saving for a down payment.

The purpose of zero-based budgeting is that you meet your needs while working towards your financial goals. By the end of the month, you should have zero (hence the name) dollars left without a job.

Example of zero-based budgeting

Let’s look at an example. Say your monthly income is $4,500 and you rent an apartment, have student loans, want to build up your emergency fund, and are planning a wedding within the next two years. Here’s what a breakdown of your budget may look like.

Who is zero-based budgeting for?

A zero-based budget can make sense for anyone who wants to get their finances in check. But it may especially be beneficial to people who let any excess money sit in their checking account each month. If you have financial goals beyond paying for your short-term needs—as most people do—a zero-based budget can help you get organized so you can consistently put money to work, even if it’s for years down the line.

This strategy works best for people who like to plan ahead and are prepared to put time and energy into their budgeting. While zero-based budgeting doesn’t have to be extremely time consuming, it can be a bit more complicated than other budgeting strategies.

Zero-based budgeting can work for anyone willing to do the work, but it can especially make sense for people who have a consistent income from one month to the other.

Why is zero-based budgeting important?

Zero-based budgeting can be important for savers who struggle to make the most of their money. If there is cash in your checking account, zero-based budgeting would require you putting it to work—a smart move considering checking accounts tend to not earn interest.

Even if you move money into your savings account each month, doing so without intention may mean you’re missing out on money. While traditional savings accounts earn 0.45% on average as of July 2024, allocating that money to a goal via an investment account or high-yield savings account will give you a better rate of return.

Zero-based budgeting: Pros and cons

As with most budgeting strategies, zero-based budgeting comes with pros and cons:

Advantages of zero-based budgeting

Puts every dollar to work

When every dollar of your take-home money is allocated to meeting a certain goal, you don’t risk missing out on years of earning interest or market returns by having your money sit idly. The strategy can also help you meet goals you may not have thought you had the money to save for, since you’ll see exactly how much money you have at the end of the month and can designate it to a milestone, such as buying a car or eliminating debt.

Can help you meet short- and long-term goals

When you get paid, it can be easy to focus on the essentials like housing and groceries and feel free to spend the rest of your earnings. But doing so can hurt your potential to reach both short-term goals that aren’t needs—such as a vacation with friends—or goals like retirement that are years, or even decades, away. Zero-based budgeting forces you to think about those goals when looking for a place to park your extra cash each month.

Can help you save more

Organizing your money can help you save more. Instead of looking at “extra” cash after you cover your basics as spending money, giving it a job can help you spend less and save more.

Customizable

Your take-home pay and goals will look much different from another person’s, and zero-based budgeting accounts for that. While some strategies, such as 50/30/20 budgeting, give you specific figures for your savings, zero-based budgeting can be adjusted to fit anyone’s income.

The strategy also makes room for anything that you want to save for, whether that be an investment property or a new blender.

Can implement with a budgeting app

You don’t have to budget on your own. Nowadays there are a plethora of budgeting apps that can help you and some, such as ​​ YNAB (short for You Need a Budget) are based on the zero-based budgeting strategy.

Disadvantages of zero-based budgeting

Requires organization and planning

Zero-based budgeting requires you to plan for the month ahead and also revisit your budget at the end of the month to ensure that every dollar has been put to work. Like most budgeting strategies, this only works if the saver is willing to organize their finances.

Time consuming

Because of the organization and planning required, zero-based budgeting requires you to spend some time with your budget. Costs and goals are likely to change over time, which means you should plan to consistently sit down each month and ensure your budget is still in line with your needs.

Challenging with inconsistent income

If you’re an hourly worker, freelancer, or have another job that comes with an inconsistent income, zero-based budgeting can be difficult. It requires adjusting your budget every month so that each dollar is still used. This can mean making some major changes if your take-home pay is $2,000 one month and $4,000 the next, for example.

How to make a zero-based budget

Start implementing a zero-based budget with these five simple steps:

1. Determine your monthly income

The first step to zero-based budgeting requires looking at your monthly income. It’s important to note that this is your take-home pay, not your pre-tax income.

2. Identify your expenses

Review your recent spending history to identify your expenses, including your housing costs, utilities, groceries, and debt payments. Once you have those essentials out of the way, estimate how much you plan to spend on other expenses over the next month, such as dining out or on gifts if it’s around the holidays.

3. Pinpoint your goals

Consider what you want to save for the short term—whether it be increasing your emergency fund, getting a dog, or throwing a party. Then, think about such long-term goals as retirement. Fidelity Investments recommends having the amount equal to your salary saved by the time you're 30, six times your salary by age 50, and 10 times by age 67. Don’t neglect to include retirement savings in your budget, no matter how far off it feels.

4. Subtract your expenses and savings goals from your income

Once you’ve forecasted your spending and saving, subtract that total from your take-home pay. The result should be $0.

5. Make adjustments

If you completed step four and the result isn’t $0, adjust your budget. Perhaps this means lowering the amount of money you set aside for long-term goals or making a debt payment beyond the minimum (if your plan allows).

Zero-based budgeting vs. traditional budgeting

Traditional budgeting involves allocating a certain amount of money for your various needs. It differs from zero-based budgeting in several key ways.

Best practices for zero-based budgeting

Be specific

A major benefit of zero-based budgeting is that it requires you to allocate a certain amount of money for every spending and saving category. While you can make adjustments throughout and at the end of the month, including as much detail as you can in your forecasts will help ensure you don’t overspend or have a lot of extra cash left over at the end of the month.

Be flexible

Just because you put a plan in place doesn't mean it can’t—and shouldn’t—change as your life does. In the summer you may want to spend extra on happy hours with friends and outdoor concerts, and that may require decreasing the budget line for savings that month. Being flexible means you’re more likely to stick to your budget.

Review your progress

Everyone makes mistakes when it comes to budgeting, but those lessons learned can help you put a better plan into place for the next month. Take a few minutes at the end of each month to reflect on how well your budget fits your life and goals, and consider what you may want to change going forward.

Alternatives to zero-based budgeting

50/30/20 budgeting

The 50/30/20 budgeting rule involves splitting your take-home pay into the following three categories:

• 50% on your needs, including housing and bills.
• 30% on your wants, such as dining out.
• 20% on savings.

Envelope budgeting

Envelope budgeting is similar to zero-based budgeting in that you're giving your dollars a job. With envelope budgeting, you designate your cash to certain envelopes with labels like “groceries” or “entertainment” and only spend what you’ve allocated for that expense.

Expense tracking

Expense tracking entails keeping a close tab on all the money you spend. This can be done by hand, via a spreadsheet, or with a budgeting app.

TIME Stamp: Give every dollar a job with zero-based budgeting

Zero-based budgeting is a strategy that requires giving every dollar a job, whether that be for expenses, wants, or long-term goals. You implement this strategy by identifying your basic costs, debt payments, short- and long-term savings goals each month and subtracting them from your monthly take-home pay.

This type of budgeting especially makes sense for people with regular income, but it can be adjusted for those with inconsistent income as well. While you can do this by hand or digitally, budgeting apps can also take some of the work off your plate.

Frequently asked questions (FAQs)

What is the major feature of zero-based budgeting?

The major feature of zero-based budgeting is allocating all your money to a certain expense or goal so at the end of the month, you’re left with $0.

Can someone with an irregular income create a zero-based budget?

Yes. Irregular income isn’t a barrier to creating a zero-based budget, but it will involve more adjustments to the budget each month.

Why is the zero-based budget the most effective type of budget?

The most effective type of budging for one person may not be the most effective type of budgeting for another. Zero-based budgeting can be very effective for people who want to ensure that they’re putting every dollar to work either for expenses or goals.