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Zero-based budgeting: Definition, example and if it's right for you

Mother playing with two children
Vera Livchak/Getty Images

As you work to make the most of your money, basic budgeting keeps your spending on track. But fine-tuning your budget could help you even more.

Zero-based budgeting is an approach where you account for every dollar earned and earmark it for a specific purpose. Also known as a zero-sum budget, it is designed to leave no money to float in your bank account monthly. Instead, you channel that money elsewhere—to pay down debt or save for unexpected expenses, a family vacation or important financial goals down the road.

How does a zero-based budget work?

With zero-based budgeting, every dollar of your monthly income should be set aside for a particular purpose. It was originally designed as a style of business budgeting to prevent money from falling through the cracks. This strategy gives you a tighter rein on your funds so you can reach your short- and long-term financial goals.

The "zero" in zero-based budgeting refers to the idea that there's nothing left over, that you've allocated everything. That doesn't necessarily mean you spend every dollar every month. It means that even money you save is dedicated to specific savings accounts or line items, like a future fund for car repairs, vacations, your kids' college expenses or your retirement.

Is zero-based budgeting right for you?

Zero-sum budgeting works particularly well if you're focused on planning ahead for certain savings goals. It's detail-oriented and can take time to manage, but it can help you be very intentional with your money. It's easier to use if you have consistent income and expenses each month, but you can use it even if your income and expenses vary.

How do you budget for savings?

Saving money amid monthly expenses is sometimes easier said than done. Paying yourself first can help you prioritize long-term financial goals. 
Learn what paying yourself first means

An example of a zero-based budget

Let's see how zero-based budgeting works in practice. While everyone's budget will look a little different depending on income and life stage, this example shows how a young family of 3 bringing home $6,000 a month might allocate their funds with a zero-sum budget.

Essentials
Monthly Expense
Mortgage/Rent
$2,000
Childcare
$1,000
Utilities
$300
Groceries/dining out
$500
Insurance
$400
Transportation costs
$200
Entertainment
$200
Debt payments
$200
Clothing
$150
Unexpected household costs
$150
 
 
Savings
Allocated Monthly
Emergency fund
$250
Nonprofit donation fund
$250
Retirement savings
$400
 
 
Total funds allocated:
$6,000

After accounting for essential living expenses, the family divides the remaining money among several savings funds. But still, those funds are flexible depending on the family—and they can change with time.

This means that while zero-based budgeting can be a more stringent budgeting method, it ultimately provides financial flexibility. You're prepared for any major expenses that pop up.

What are the pros & cons of a zero-sum budget?

Zero-based budgeting can help families avoid casual spending and instead save for important long-term goals. However, it's not for everyone. Here are some of the benefits and drawbacks of this strategy.

Advantages of zero-based budgeting

The main urge that zero-based budgeting tames is impulsive spending. While you might set up a specific allocation for purchasing "wants," you won't be tempted by bad spending habits. When your goals and budget are carefully thought-out, it's easier to stick to.

Also, it's customizable: You don't have to save for just one future goal. If you reach one goal, like saving for a down payment on a house, you can change your allocation to a new one. While a given month's budget is rigid, you can switch priorities as you move through life.

Drawbacks of zero-based budgeting

Zero-based budgeting is work intensive. It requires time to set up your system and then to track your monthly expenses and savings. It also can be difficult without a stable income—say, if you're a freelance worker, or you work hourly and your schedule changes often.

However, it's still possible to make a zero-sum budget work. You can plan your monthly budget based on your minimum monthly income. This still can help you avoid unnecessary spending and lets you add more to your savings when you do make more than your minimum.

How to create a zero-based budget

If, after considering the advantages and drawbacks, you're ready to pursue zero-based budgeting, the steps are simple:

  1. Review your last six months of spending and saving. Figure out an average for your spending and saving.
  2. Make a first month's budget based on your realistic spending and saving, as well as any small changes you'd like to see. This could include less casual spending and more saving for your family's future needs.
  3. Adjust the spending and savings plan each month for the first few months to make sure it feels sustainable long-term.

Find a budgeting method that works for you

While zero-based budgeting can be a useful tool, the best budgeting system is the one that works for you. If this method doesn't suit you, the 50/30/20 budgeting method could be another option.

local financial advisor can introduce you to new budgeting styles that fit your family's rhythms, while ensuring you get the most out of your money and move toward your long-term financial goals.

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