Budgeting is the cornerstone of a healthy financial life, but for some, traditional budgeting leaves something to be desired.
If you're looking for an alternative, you might consider zero-based budgeting (also called the ZBB budget). Here, every dollar has a destination, whether that’s going toward rent, retirement or savings. (Or, in the case of businesses, it ties funds to specific line items.) That way, it can help steer money toward financial priorities.
Let’s explore how zero-based budgeting works, including its benefits and challenges, best practices and how it differs from traditional budgeting.
How zero-based budgeting works
With the ZBB budget, you build your budget from scratch each month based on your expected income. For example, you might allocate a certain amount to bills, savings or a concert ticket. You assign funds until each dollar you make is accounted for.
Here are the steps to set up a zero-based budget:
- Collect your income information: Be sure to include all sources of income, noting the exact amounts you receive each month.
- Record your expenses: Make a note of your past expenses across your various accounts or line items.
- Create a list of allocations: Assign money to each of your financial categories, including expenses, goals and any discretionary spending, until that amounts to your total income.
- Track your spending: Keeping a close eye on your spending can help ensure you stick to your ZBB budget. If your income changes or something unexpected comes up during the month, you’d need to create a new ZBB budget or adjust it to accommodate those changes.
Benefits of zero-based budgeting
The zero-based budget has several key advantages:
- Can help minimize overspending: By setting a spending limit for different costs or categories, you may avoid spending too much in other areas
- May illuminate cost-cutting opportunities: In creating your ZBB budget, you can get a clear picture of where your money is going and find areas that you want to cut back on if they seem out of proportion
- Ensures a strategic financial approach: By keeping your financial goals in mind as you assign values to your expenses, you may adjust those figures so that they’re more aligned with your goals
Challenges of zero-based budgeting
Although the zero-based budget has advantages, there may also be challenges worth considering:
- Can be overwhelming: Zero-based budgeting can be a more high-maintenance option, requiring more time and effort than you may be used to, especially if you’re new to budgeting
- May lead to cutting things too close: If you aren’t used to spending within certain limits or an unexpected expense comes up, this budgeting method may make it difficult to bridge the gap between your plans and actual spending habits
Zero-based budgeting: best practices
Zero-based budgeting can be a powerful tool, especially if you use it strategically. In general, setting up time to regularly review your finances and looking at your past spending habits can help you create a realistic zero-based budget. That way, you may be more likely to stick to your plans. Including a miscellaneous category may also help you stick to your ZBB budget.
Zero-based budgeting and traditional budgeting: the difference
The main difference between zero-based budgeting and traditional budgeting is the requirement to allocate all of your income.
With a traditional budget, for example, you might simply ensure that you can cover your necessary expenses. Any additional funds may not have a specific function, making them easier to lose track of. With a zero-based budget, however, that money would already have a purpose, from savings to investments.
On the other hand, a zero-based budget may require more time than a traditional budget, as it's a more hands-on approach.
Zero-based budgets can be somewhat overwhelming. However, for those who want to be intentional about how they spend money and how they progress toward various goals, a ZBB budget may make sense.
Disclosure: This article is for general educational purposes. It is not intended to provide financial advice. It also is not intended to completely describe any Citi product or service. You should refer to the terms and conditions financial institutions provide for various products.
