Zero budgeting can mean two different things. In business, it means approving all budgets from scratch instead of basing a budget of of the previous year’s expenses. In personal finance, however, zero budgeting basically means deducting sums from your income until you have no money remaining to allocate. The funds are allocated weekly, or monthly, until the remaining net income is zero. This practice can be used to ultimately balance your finances, but it is not recommended if you are subject to certain unknown expenditures, need emergency savings, are not contributing regular to your taxes or are saving toward a long-term goal.
#1 Unknown Expenses
Some individuals have very consistent expenses. They know when they will be required to pay an insurance bill, a car bill or a credit card bill. Most individuals have been budgeting for years, and they know what they spend each month on each necessity and luxury. You may not fall into this category if you are living in a new city, just had a new child or are owning a home for the first time. Any major change, in fact, can throw off your existing budget, and you will need more wiggle room than a zero-sum plan allows.
#2 You Have no Emergency Fund
You can compensate for certain unknown expenses through an emergency fund. If you have been able to build up a sufficient emergency fund to date, you may not need to be concerned with continuing to build on that fund. You should have the liquidity to immediately cover three months of living expenses if you were to lose your income. Zero budgeting is not a good idea unless you have met this goal. Allocate more dollars toward savings wherever possible until this is a reality.
#3 You Have Uncertain Tax Obligation
By making regular withholding payments toward your income taxes, you can be fairly certain your tax liability will be covered at the end of the year. However, some individuals do not have the luxury of paying a withholding on every paycheck. For example, freelancers, independent contractors or those who receive most of their money in tips and bonuses need to budget for taxes. Zero budgeting based on your pre-tax income will leave you with a big check to pay and no money to pay it with come April. Even zero summing with an estimated after-tax income is risky in case you miscalculate your tax burden during the year.
#4 You Need to Think Long-Term
Short term goals are easily met with zero-sum budgeting. However, the process rarely meets long term goals. If you know you need to save for a home, retirement, college or a wedding, you need to start thinking about how to save money each month instead of spend your entire income. Of course, part of your zero sum balance can be allocated toward a savings account for these items. Just make sure you are setting enough aside to meet your goals before you allocate any dollars toward entertainment.