What is zero-based budgeting?
If this is the first time you've heard of the zero-based budgeting method, it focuses on this simple equation: income minus expenses = zero. That doesn't mean you have to spend every dollar you make, but that every dollar is put to a specific use. This might look like adding to an emergency fund, paying off debt, buying groceries, having a night of fun or even creating a financial safety net to protect you from overdraft in case you overshoot a spending category. Planning and categorizing your income before spending it can help you become more intentional with your money and reach your goals faster.
However, planning your budget is only 50% of the work — tracking your spending is an essential part of this budgeting method.
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Start Trading TodayHow do you use the zero-based budget method?
In just a few steps, you can set up your first zero-based budget.
Step 1: List your income
List all sources of income you are going to receive within the month or budgeting period. This includes your 9-to-5 income, side hustle income, government benefits and anything else you may have coming in as earnings.
Step 2: List all your expenses
Expenses can fall into several categories, so think broadly here. Not only does it include bills and miscellaneous spending, but your necessities, saving, investing and debt repayment all fall under expenses as well.
Step 3: Subtract expenses from your income
Grab a calculator or use your spreadsheet to do your calculations.
Step 4: Evaluate and revise your budget
After subtracting your expenses from your income, are you left with more than $0? You can reshuffle here to increase your spending on some priority areas. Are you saving and investing enough each month? Do you have an emergency fund built up? Is there a buffer in your budget to protect from overspending? Work with the numbers to bring the balance down to zero!
Are you left with less than $0.00? Reflect on what items in your budget need tweaking. Temporarily prioritizing some categories over others can help with short-term issues. Instead of slashing the essentials, can you think of ways to increase income this month to reach that zero goal?
You should aim to begin your budgeting period with every dollar you make having a role. Think of it as giving each dollar a job instead of having them aimlessly wander in and out of your bank account.
Step 5: Track your spending
Track your spending against the budget plan you created as each dollar is used. A great feature of a zero-based budget is its flexability — as you spend and track, if you find you are underspending in one area, you may shift your budget for that category to an area where you expect you may be overspending. This will keep the overall balance of the budget at zero.
What are the advantages of zero-based budgeting?
Zero-based budgeters love this method because it gives them control over their spending. Every dollar is given a purpose. This often helps people focus more on their short- and long-term financial goals, like getting out of debt or saving for retirement.
You can use the zero-based budget alongside other budgeting approaches. Want to focus on the pay-yourself-first method? Prioritize savings and financial goals in your zero-based budget before you spend money.
Do you like the 50/30/20 rule? There is no reason why you can’t apply that budgeting framework in a zero-based budget. It would just require additional calculations to ensure each of your needs, wants and savings categories align with your desired allocation. The overall equation is: Income (100%) - Needs (50%) - Wants (30%) - Savings (20%) = Zero.
What is the 50/30/20 rule?
The 50/30/20 rule is another well-known budgeting method, introduced by US Senator Elizabeth Warren and her daughter Amelia Warren Tyagi in their 2006 book All Your Worth: The Ultimate Money Plan. Simply put, the 50/30/20 rule budget method allocates 50% of your budget to your needs and essentials, 30% to your wants, and 20% to your savings and debt. However, it has fallen out of favour recently as cost of living increases and inflation have eaten away at Canadians’ purchasing power, making it difficult to fit all needs and essentials into only 50% of the budget. Is it still possible to get your budget to a 50-30-20 split? It may not as achievable in 2024 as in 2006 when the book introduced this budget method, but this framework can be an excellent guideline for which to aim. I suggest using it as a guideline or goal, not a hard and fast rule.
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Get A QuoteWhat are the disadvantages of zero-based budgeting?
One disadvantage of the zero-based budget is that it can be more time-consuming. To best utilize the power of this style, you need to track your expenses. Whether you spend five minutes a day inputting your spending into an app, notebook or spreadsheet, or 30 minutes once a week, tracking your expenses is the key to zero-based budgeting success. You have to be willing to put in the time in order to see the results.
Bottom line
There are many different budgeting styles out there. If you have tried others before and they didn't feel like the right fit, I challenge you to try a zero-based budget and track your spending for three months. You may have more control over your spending, get closer to your financial goals each month and reduce your financial stress. This is what the proper budget can help you accomplish.
Sources
1. Financial Consumer Agency of Canada: Financial Well-Being (May 29, 2024)
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