The zero-based budget method allows for allocating and using every penny of your income. That does not mean there's no control or direction on how you spend, but it requires that you outline everything you are spending money on thoroughly. It will include paying down your debt, saving for retirement, and putting money into an emergency fund while covering fixed and variable expenses. It also consists of the things you need to spend money on and discretionary spending, or things you want.

Overview

How does zero-based budgeting work? You'll create a budget that breaks down where all of your money is going, including:

• Needs
• Wants
• Savings
• Debt repayment
• Short-term goals
• Long-term goals

By month's end, your income should have been used on the goals you've set, leaving nothing behind as leftover. This is different from living paycheck-to-paycheck, a common misconception. In this method, you're just working to be sure that you're accounting for everything, so there's nothing left over – but that doesn't mean you're spending it all. A good portion of your income will still go towards investments and savings.

Budgeting Steps

Follow these steps to set up and start using a zero-based budget.

1. Determine your income. The first thing to do is calculate your income from all sources. This should include any money you receive during the month. This tells you how much money you will use to pay toward various expenses.
2. Set up your expenses. If you need to figure out how much you spend each month on expenses (needs and wants), you can track your expenses over the last three or so months. Use your bank statements and other information to help you understand how much you spend in each area.
3. Set up your expenses in categories. Divide all expenses (from your rent payment to the daily coffee shop visit) based on "needs" or "wants." This allows you to prioritize the things you absolutely have to have to survive, such as paying your rent or mortgage, car payments, insurance coverage, and groceries, compared to your wants which may include subscription services, gym memberships, and dining out.
4. Allocate a specific amount towards each expense you have. Base this on the amount of money you typically spend on those expenses. If your rent is $800 monthly, put $800 towards rent. If you pay between $200 and $400 monthly in grocery costs, allocate $300 towards this and stick with it.
5. Incorporate savings and debt repayment. Your budget has to also include putting some money towards your savings (emergency or long-term savings) as well as extra that's paid towards your debts to pay them off. Establish the percentage of debt repayment and savings based on your needs, aiming for 20% or more of your income when possible.

When you create your budget, you should plan for where every dollar will go each month. This will help give you a clear path for savings, paying down debt, managing entertainment costs, and even covering goals like building savings to buy a home.

Zero-Based Budgeting Example

Let's create a basic zero-based budget to help you see how it may work for you.

• Income: You determine that, with all sources of income, you bring in $3,000 per month.
• Fixed expenses: Your fixed expenses are broken down first. This includes rent, mortgage, insurance, etc. Allocate based on how much you're spending. Here's an example:
  • Rent: $700
  • Groceries: $300
  • Insurance: $80
  • Phone bill: $60
  • Health insurance $80
  • Utilities: $130
  • Daycare costs: $400
• Variable expenses: In this area, write down everything you're likely to spend and give each category a goal:
  • Gifts: $20
  • Gas: $150
  • Clothing purchases: $50

Thus far, your expenses (fixed and variable) equal: $1,970.

• Savings: Put a certain amount you select towards savings each month. For example, allocate 20% of your income towards savings. That would be $600.
• Debt Repayment: How much extra will you put towards your debt each month? For example, you may put $100 monthly in addition to minimum payments towards your credit card.
• Discretionary Spending: Allocate money towards the things you want to buy but may not do so if you cannot afford to, such as eating out or buying electronics. In this case, you may put $330 towards discretionary income.

In this example, your total expenses, savings, and debt repayment equal $3,000.

Is the Zero-Based Method Right for You?

This method can work for most people but takes careful planning and focus. If you do not have a regular income or a lot of variable expenses, this is more difficult when there is no steady income stream.