Intro to Zero-Based Budgeting (aka "Envelope Budgeting")

Published 2024-12-12

Zero-based budgeting is the same as envelope budgeting, so here it is in a nutshell. You have a stack of paper envelopes and a pile of dollar bills, representing all of the money you currently have (excluding investments - see below).

On the stack of envelopes, you write what each one is for, in descending order of importance. So on the first envelope you write “Rent”. On the next you write “Electricity”. And then groceries, cell phone, car insurance, car repairs, dining out, hobbies, and so on.

Now from your pile of money, you take however much you’ll need for rent this month and put it in the first envelope. Repeat with groceries, and so on. “Car repairs” isn’t a predictable monthly expense, so in that envelope you’ll put however much you want to have set aside for unforeseen breakdowns. Continue on until you have assigned all of your money. This is key, and this is why it’s called “zero” based budgeting.

If you have extra money leftover (lucky you!), maybe you start funding next month’s categories (especially if you have unpredictable income). Or maybe you start funding an “emergency” envelope, which you only touch in case of actual emergency (realistically you should have several months worth of expenses set aside in an emergency category). If you still have some left, put it in investments if you have them.

Some of the envelopes you’ll completely empty and refill every month (rent, cellphone, groceries, car insurance). Some envelopes you’ll only spend from when you need to (car repairs). If you don’t empty a given category in a month (say, groceries), no problem! That extra money will just sit in the envelope until next month, and you’ll replenish less to that envelope.

If you find that you don’t have enough money in a given envelope to cover an expense, then you steal from another envelope in order of least importance ($40 short on groceries? Take it from dining out. No more dining out this month).
You might find it helpful to write the amount you need on each envelope as a reminder of how much to put into it. This is equivalent to “Goals” in YNAB and Actual. It’s also helpful to group your envelopes (“categories”) together - for example, your predictable monthly spending (rent, groceries, insurance, cellphone, internet) might be grouped into “Bills”. Important but irregular categories (car maintenance, medical expenses) might be grouped into “Non-monthly Expenses”). Dining Out and Hobbies might be grouped into “Discretionary spending”. These are called “Category Groups” in YNAB and Actual.

Credit cards

The way YNAB (and I believe Actual) handles credit cards trips some people up at first, but IMO it’s quite elegant. When you add a credit card to your budget, two separate things are created: an account where the transactions are tracked, and a category (envelope) for paying off your credit card. When you make a purchase on your credit card (and record the expense), YNAB automatically moves that amount from the category its currently in (e.g. “groceries”) to your credit card payment category. This ensures that you always have the money set aside to cover expenses on your credit card - the credit card payment category should always be the same as the balance on your card!
If you’re already carrying debt on your credit card, then you won’t have the full amount available to pay it off right away, but you can create a goal in YNAB to add a little extra to your credit card payment category each month until its paid off.

Investments

You can track the value of investment accounts in both YNAB and Actual as off-budget accounts. They will contribute to your net worth report, but you don’t assign the money inside them to categories like you do with any normal bank accounts. When you contribute money to them, it will show up as a transfer rather than an expense.
Loan/Debt Accounts
Loan accounts can be used to, e.g., track the balance remaining on your car loan or a line of credit. They work just like Investment accounts, but in reverse.

More tips

• Reconcile often! Especially if you’re not using automatic import. Reconciling ensures that your balances in YNAB/Actual match your actual bank account. If you aren’t doing this regularly YNAB might drift out of sync with your bank balances, and you can no longer trust your categories - you can’t be sure that you actually have the money set aside that you think you do. I like to reconcile weekly.
• Using YNAB/Actual eliminates the need to create multiple savings accounts to squirrel away money for different purposes (do you have a separate account for saving for a vacation, or a big expense?). You still can have different accounts for other reasons if you want/need to, but they’re all treated as one big pool in YNAB - Categories are where the segregation of money happens. If you create a category called “New TV” and add some money to it each month, you can be sure that you won’t accidentally spend that money on something else (as long as you’re reconciling frequently - see above). This is way more flexible than using dedicated bank accounts.
• Refunds/loaning money. Generally any money you receive goes into the “To Budget” (Actual) or “Ready to Assign” (YNAB) category before you assign it between your categories. However, let’s say you go out to lunch with a friend and you cover them for the meal (you enter the entire bill of $50 “Dining Out” category). When they pay you $25 back later, if you enter the income into “To Budget”, it’s going to show up as income on your reports, and it’s going to look like you spend $50 on dining out that month. Instead, when they pay you back you can record the income directly back to your “Dining Out” category. That way it just offsets the amount you already spent rather that appearing as income. You can handle returns/refunds the same way.
• Owe someone money? Create a category with a goal for the amount you owe them. Once the category is fully funded, pay them back.

More Resources

YNAB’s guides, blog, and help center are very good, as are Nick True’s videos on YouTube. They should mostly be applicable to Actual as well. I haven’t spent much time with Actual’s documentation, but at a glance it also appears to be very good. The YNAB subreddit is also very helpful.

I’m also happy to do my best to answer questions - email me!