Budgeting. This is a term that has earned a poor reputation among many due to its time consuming and boring nature. I mean who’d want to keep on tracking how every penny is spent?
Its everyone’s wish to spend as much as they want without having to limit themselves. However, this is only possible if you were born rich or inherit a fortune which doesn’t happen to a large percentage of people. This only means that at one point you have to learn how to budget.
Budgeting is one of the most important steps in your journey towards financial independence as it will help you achieve your goals. It’s how you handle your personal finances that determines your success story. Some of us operate without a budget, and this may lead to financial constraints.
Without a budget you may find yourself overspending due to factors like impulse purchases. You may also fail to create a balance in your life between your basic needs and your entertainment needs or savings.
What Is a Budget?
A budget is a financial blueprint you use to estimate your income and expenditure for a given period. You need a budget to succeed in managing your finances and to attain the financial goals you set.
Some of us fail to budget because we don’t have the know-how. The good news is you can budget effectively without mastering the sophisticated budgeting techniques and instead using a simple yet highly effective rule.
How? You can rely on the easy 50/30/20 rule.
What Is The 50/30/20 Rule?
The 50/30/20 rule is a budgetary or money management technique that distributes your income into three categories. The particular groups will guide your expenditure based on a given earning period.
The method’s simplicity and usefulness have made it very popular among beginners and even budgeting experts.
A Brief History on The 50/30/20 Rule
The 50/30/20 Rule was brought to light by Elizabeth Warren, a U.S Senator of Massachusetts and a bankruptcy expert from Havard. She explains it in her book: All Your Worth: The Ultimate Lifetime Money Plan, which she has co-authored with Amelia Warren Tyagi, her daughter.
Senator Warren has been ranked among the top 100 Most Influential People by Time Magazine.
Benefits of the 50/30/20 Rule
- Simple to Use: You can operate a 50/30/20 budget with little commitment, and without the need for spreadsheets. You can set it up in a matter of minutes and maintain it with ease.
- Flexible: Anyone can use the 50/30/20 Rule. It is compatible with any lifestyle.
- Useful: You will be able to benefit from this plan in terms of less expenditure, an increase in savings, and you will have success when it comes to achieving your financial goals.
How Does The 50/30/20 Rule Work?
The 50/30/20 rule subdivides your budget into three specific categories. They include the Needs, Wants, and Savings. Your needs should take up 50% of your after-tax income; you should allocate 30% to your wants and save 20%.
You may have figured out what to do at this point. However, you need to read through the step by step guide below to establish what your needs should be, what your wants are, and your savings allocations.
Let’s Clarify the Categories
1. What Are Your Needs?
Needs are bills that cover things that you require to survive. Examples of needs include groceries, rent, health care, insurance, car payments, mortgage payments, and utilities.
People easily cross the line between needs and wants. For example, we tend to substitute dining out with groceries. Buying groceries is a healthy move that can help you save more compared to dining out or buying snacks. Here are 21 Tips To Help You Save On Groceries.
That is a budgeting error because groceries are needs, and dining out is a want. A teenager could say they need a text plan subscription, but that also falls under wants. Distinguishing between needs and wants is important in helping you budget with ease.
Related post: 15 Easy Ways to Lower Your Utility Bill.
2. What Are Your Wants?
Wants are partially essential bills, but you don’t need them — for example, the text plan subscription. Wants include the entertainment and enjoyment aspect of your life. For example, when you substitute a hamburger for steak. Steaks are usually more expensive as compared to burgers.
Other examples of wants include vacations, the latest mobile phones, high-speed internet, fancy cars, movies, and Netflix, among other hobbies and interests. Consider wants as the extra things in your life rather than the basic needs.
3. What Are Savings?
We all face emergencies at a certain point in our life. Some may be little; some may be major. Savings provide the financial cushion to deal with emergencies. Savings need you to make sacrifices. It is an amount you refrain from using for your greater good. You can save money even on a tight budget. Read more on How To Save Money On A Shoestring Budget.
How Do I Implement The 50/30/20 Rule?
1. Evaluate Your Income After Tax Cuts
- As a law abiding citizen, you are obliged to pay taxes such as income tax, local tax, state tax, social security, and medicare. There are two approaches to determine your tax. It depends on whether you are an employee or self-employed.
- An employee: You can quickly figure out your income subject to budgets if you look at your paystub. A pay stub is a piece of paper that indicates the charges on your income to cater for expenses such as tax, insurance. Add all the deductions except tax. That will be your income after tax.
- Self-employed/ employer: As an employer or a business owner, you are tasked with the responsibility of estimating your quarterly earnings and remitting tax to the government. Your budget-able income will be all your income minus taxes and business expenses. You should note that you will also need to pay the self-employment tax.
The self-employment tax is twice as much as social security and medicare paid by employees.
2. Assess Your Needs and Limit Them to 50% of Your Income
You will start making budget allocations in this step. What are your needs? How much do you allocate to these needs every month? Needs have a significant impact on your life. For example, the electricity covered by your bill will serve numerous purposes from food preservation lighting, etc.
There is a chance that you may blur the line between your needs and your wants. Take an example where you are required to make a minimum payment of $30 on your credit card. The $30 is a need. However, if you make minimum payments of $100, the extra $70 will fall under wants.
Furthermore, it would be best if you put a strict policy on the percentages. Make sure you do not exceed the rate as you may end up causing financial strains. If your needs take more than 50% of your income, you should make cuts on the expenses.
Related post: 10 Personal Finance Tips To Help Make You Rich.
3. Establish Your Wants and Limit Them to 30%
Some people have the toughest time when it comes to regulating their wants. How do you avoid buying the attractive pair of shoes you spotted at the mall? You need to practice restraint and look for cheaper options.
For example, you can get another cool shoe at the discount store. You may find the rules tricky, but with time, you will come to acknowledge their purpose.
4. Allocate 20% To Savings and Debts
Savings and debts should take up 20% of your income. You should note that your credit card minimum payment, your car loan, and mortgage are the only debts that fall under needs. Other debts, such as personal debts should fall under the 20% allocation.
You will also need to contribute to your retirement account and your emergency fund.
5. Use a Spending Tracker
You can either download a spending tracker or rely on manual systems. This step is optional. Either way, you need to establish a system to track your spending. You can count on software that helps you track your spending.
Spending tracking software has better features than manual spending tracking. For example, you will be able to link your bank account to the software to help you monitor your spending. Furthermore, you will also come across software that will help you categorize your expenditure.
Examples of software that track spending are Personal Capital, Mint, and Trim. You can also combine the effort of a couple of platforms to have access to more features. Furthermore, there are apps that pay you to shop that you can take advantage of and save money.
- Always make your allocations after you have deducted and paid your tax.
- Always track your expenditure. You can opt for automation software to make your work easier.
- Do not exceed the percentage for any of the categories. Make some financial cuts and sacrifice some expenses if you feel your budget could exceed the allocated portions.
- Draw a fine line between needs and wants. The wants can especially pass for needs, and this will bring about unnecessary constraints.
Personal debts should fall in the 20% section. However, the significant debts, including credit card limit payments, car loans, and mortgages, should fall under the needs section.
Have you had to set saving as one of your new year goals? I have. I can say that I was not doing a great job of reaching this goal year in and year out until I stumbled upon the 50/30/20 budgeting rule.
I have been able to manage my finances with ease, and I can say I have achieved numerous of the financial goals I set. The 50/30/20 Rule is straightforward and effective.
Here Is a Summary of What You Need to Do:
- Allocate 50%of your income after tax to your basic needs
- Dedicate 30% of your income to your wants and hobbies
- Allocate 20% of your income to savings and debts
The 50/30/20 rule is a budgeting technique that can work for anyone, even those without accounting experience, and I highly recommend it.
What method have you been using to run your budget before? How effective is it? Are you ready to try the 50/30/20 rule?