Zero-based Budgeting 101: Why It Really Works

Budgeting is the best way to get control of your finances, but it’s also a concept that may leave a bitter taste in the back of your throat.

Creating this kind of roadmap or spending plan doesn’t have to mean spending less, however. It simply means spending smarter. Making a budget is all about building better money habits and making sure your hard-earned cash is going where you need it to go — and also where you want it to go.

While there are countless different approaches to budgeting, zero-based budgeting is one strategy that’s relatively flexible and, most importantly, incredibly effective. 

What is zero-based budgeting

Zero-based budgeting is a budgeting method where you try to make the total of your income minus your expenses equal zero each month (or any period of time of your choosing). The goal is to account for every penny you earn and make sure each cent goes exactly where you want it to go.

You might be thinking that sounds crazy. Why would you want to have zero dollars to your name?

Zero-based budgeting is not about having no money though. It’s merely about knowing exactly where the money you have in your bank account is going: toward saving, investing, or spending.

For example, if each month you earn $5000, then you might invest $1000 in a retirement fund, put another $1500 aside in a high-yield savings account or toward debt repayment, and leave the remaining $2500 in your checking account (taking care to assign each dollar a place to be spent: housing, food, entertainment, etc.)

Why is zero-based budgeting important?

The obvious benefit of zero-based budgeting is that it forces you to be incredibly aware of what’s coming in and out of your bank account. This kind of deep understanding and careful planning can help lower your risk of spending more than you have. It can also reveal opportunities for you to cut down on unnecessary spending and increase the likelihood that you’ll meet your financial goals around saving, investing, and debt repayment.

What’s more, zero-based budgeting is an attractive budgeting method because it’s flexible, giving you the freedom to choose exactly how much of your earnings will go here or there.

How to create a zero-based budget

1. Work out your monthly income

This should be based on the amount you actually take home. So be sure to subtract any taxes or withholdings if these aren’t automatically deducted from what you earn. Additionally, don’t forget to factor in any sources of income you may have beyond your paycheck. This could include child support or alimony, the extra bucks you bring in thanks to gig work, or even any earned interest from savings accounts.

2.  Add up your monthly expenses

If this feels overwhelming, start with the big four fixed costs: housing, utilities, transportation, and food. From there, work in additional costs, like insurance, childcare and education fees, memberships and subscriptions, and everyday living expenses outside of food. Don’t forget to make a line item for irregular expenses, including financial outlays for car registration fees, passport renewal fees, etc.

Most importantly, don’t put too much pressure on yourself to account for every single expense immediately. It may take two to three months to track your spending and get a more accurate understanding of what’s going where.

3. Set your financial goals

Next, outline what you’d like to achieve in terms of saving, investing, or dept repayment. These might be big shoot-for-the-moon goals, like building up a nest egg for a down payment on a house, or smaller goals, like creating an emergency fund that can keep you afloat for three to six months if you suddenly stop earning. Then, assign a time period in which you want to achieve your goals and calculate what you’d need to put away each month to hit your target.

4. Factor in the fun stuff

After that, try to pinpoint what you spend on all the bits and bobs that make life worth living: costs associated with hobbies, entertainment, shopping sprees, etc. Check out your bank statements to make sure you have a good grasp on this category. You may even be surprised to find out you’re overspending despite your best efforts.

5. Balance the books to zero

Finally, subtract all of your expenses, including the amount you earmarked as part of your financial goals, from your income. If you end up in the red, see where you can cut costs before you adjust your expectations when it comes to meeting your financial goals. If you’re above zero, consider putting a bit more aside or giving yourself permission to enjoy a few “luxury” items.

Once you’ve mapped out a budget that equals exactly zero, commit to tracking your spending and staying within the lines you’ve drawn for yourself. That may mean using a budgeting app, setting up automatic bill payments or transfers to savings accounts just after payday, or even using the envelope system if you’re a cash-in-hand type of person.

Whatever you decide, be patient with yourself — it may take a few pay periods before you get the hang of it. Good luck!

The information contained herein was prepared for general information and educational purposes only and should not be construed as professional, tax, financial or legal advice or a legal opinion on specific facts or circumstances. Eloan a Division of Banco Popular de Puerto Rico, its subsidiaries and/or affiliates are not engaged in rendering legal, accounting or tax advice. Please consult with your attorney, financial consultant/planner, accountant, and/or tax advisor for advice concerning your particular circumstances.