Zero-Based Budgeting

What Is Zero-Based Budgeting?

Zero-based budgeting is a budgeting strategy that involves assigning each dollar of your income to a specific monthly expense, so your income minus your expenses always equals zero. The point of zero-based budgeting is to avoid overspending and to ensure that all the money you make serves a purpose.

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Key Things to Know About Zero-Based Budgeting

• Basic idea: In a zero-based budget, the amount you earn minus the amount you spend each month must equal $0.
• Budgeting steps: To prepare a zero-based budget, gather information about your income and spending, set broader financial goals (e.g. building an emergency fund), then subtract each expense one by one until every dollar of your income is accounted for.
• Spending guidelines: Try using the 50/30/20 rule. At least 50% should be subtracted for necessities, while 20% should be used for savings, investments and paying off debt. “Wants” should take up no more than 30%.
• Budgeting tools: Tools such as WalletHub Premium can make tracking your expenses much easier.

How to Create a Zero-Based Budget

1. Determine your income. Figure out how much money you take in every month, after tax, so you know how much you’re able to assign to your expenses.
2. Figure out your monthly expenses. Based on your usual monthly spending, figure out what expenses you have and how much money you typically need to put toward them.
3. Set goals for your budget. What do you want to do with any money you have left over after paying for your essential expenses? Common goals include building an emergency fund, setting aside a certain amount of money for regular savings, paying down existing debt, or growing your investments.
4. Subtract your essential expenses. Starting with the amount of your monthly income, subtract the amount of money you’ll owe for each essential monthly expense. This includes things like rent/mortgage payments, gas, groceries, utility bills, insurance and other things that you need to take care of no matter what.
5. Subtract money for your financial goals. Designate funds toward the goals you previously set. We recommend dedicating at least 20% of your total budget to paying off debt, saving or investing. You can do all three, but the greatest amount of money should go toward your main goal.
6. Subtract your “wants.” With the money that’s left, you can continue to subtract the cost of non-essential things that you want, such as dining out, expenses related to your hobbies, or monthly subscription services.
7. Stop when you reach zero. You can continue subtracting expenses until the amount left in your budget equals $0. At that point, every dollar is accounted for. Just make sure you’re not spending wastefully in order to reach $0 – you can always allocate extra money to saving and investing.
8. Double check your budget. Go through and make sure that all of your math is correct and that you haven’t left out any important expenses.

Once you’ve made your zero-based budget, you should track your progress every month to make sure you’re actually following the plan you made. At the very least, you should have a spreadsheet where you can mark down the info, but we also recommend trying out WalletHub’s budgeting tools, which can help you stay organized. Anyone can budget on WalletHub for free, but if you join WalletHub Premium, you’ll also be able to sync your accounts to track your spending automatically and reduce most of the legwork.

Zero-Based Budgeting Example

To fully understand zero-based budgeting, it helps to have a concrete example. Below is a sample budget for a typical American household, starting with the real median household income of around $5,350 per month. You can see each item in the budget, how much it costs, and how much is left in the budget after allocating the money.

As you can see, after accounting for all the monthly expenses, the amount left in the budget is exactly $0. But that doesn’t mean all the money is gone, as $1,100 went to the budgeter’s emergency fund, savings and investments.

Zero-Based Budget Advantages and Disadvantages

While a zero-based budget can be a great tool for helping you organize your finances, it does have some potential downsides as well. Below, you can compare the pros and cons of this budgeting strategy to see if it’s right for you.

Advantages of Zero-Based Budgeting

• It helps you keep your finances organized.
• It isn’t as strict about how much you need to spend on certain things as some other budgeting models.
• It makes sure every dollar of your income is accounted for, and helps you avoid the temptation to overspend.
• It’s simple and straightforward.
• If your income and expenses vary from month to month, it’s easier to use this strategy than it is to set specific dollar amounts to spend on things every month.

Disadvantages of Zero-Based Budgeting

• Since it requires you to plan out your expenses in a very specific way, it may not work as well with certain budgeting tools as other budgeting strategies. But it’s very easy to make a spreadsheet and use tools like WalletHub Premium to track your expenses.
• If you don’t know exactly how much something will cost you ahead of time, and the amount you subtract is off, you may need to adjust the plan mid-month. For example, if you think your heating bill will be $100 and it’s actually $150, you need to remove $50 of expenses from elsewhere to get back to zero.
• Some people may feel tempted to subtract less money for important financial goals so they can fit in more of their “wants.” Not putting enough toward your goals is a danger for any budgeting strategy, but it can be more prominent here since there’s less guidance about how much to set aside.

Zero-based budgeting isn’t the only strategy to consider. You can learn more about what a budget is and how to make one here on WalletHub.

Zero-Based Budgeting for Businesses

Businesses use the term zero-based budgeting differently than the way it’s used for personal finance. Instead of the word “zero” referring to having $0 of income left at the end of the budgeting process, it refers to starting the entire budgeting process from scratch each year or after a certain period determined by the business.

The biggest part of zero-based budgeting for a business is justifying each expense. In other words, just because something received money in a previous budget doesn’t mean it should receive the same amount of money in future budgets (or even any money, in some cases).

Going back to the drawing board like this can save businesses money in the long term because they’re not just giving mindless increases to every budget item each year, but rather constantly reevaluating what’s necessary and where they can cut costs.

Ask the Experts

WalletHub asked a panel of experts to share their thoughts on zero-based budgeting. You can click “Read More” under each expert’s name and title to see their answers to the following questions.

1. Who should try zero-based budgeting?
2. Who is most likely to struggle with zero-based budgeting?
3. Do you have any tips for getting the best results from zero-based budgeting?

Ask the Experts

Paul R. Harrison
CPA, CFP - Teaching Assistant Professor - Daniels College of Business - University of Denver
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Kurt S. Schulzke
JD, CPA, CFE – Professor of Accounting & Law, Mike Cottrell College of Business – University of North Georgia
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Jay Brandi
Ph.D., CVA, Professor, University of Louisville, College of Business
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Maria H. Sanchez
Ph.D., CPA, Professor of Accounting, Director - Master of Accountancy – Rider University
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John W. Diamond
Ph.D., Edward A. and Hermena Hancock Kelly Fellow in Public Finance, Director, Center for Public Finance, Baker Institute, Rice University
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Jerold Zimmerman
Ph.D., Professor Emeritus – Simon School of Business, University of Rochester
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