Wondering where all the money has gone and now waiting on the next paycheck, perhaps budgeting by 50/30/20 rule will help you.
Elizabeth Ann Warren is an American politician and former law professor serving as the Senator from Massachusetts and formerly a law school professor specializing in bankruptcy law coined the “50/30/20 rule” in her book “All Your Worth: The Ultimate Lifetime Money Plan.” for spending and saving with her daughter
So what is the 50/30/20 budget rule?
The basic rule is you need to divide your after-tax income and allocate it to different categories. You can use the budgeting calculator on this site.
Of which you need to allocate 50% of your income to necessities.
30% of your income to your wants
20% will be allocated to your savings or debt repayment.
If you are working for an employer then mostly the tax is withheld and paid to your account. The budget that you will be planning with the 50/30/20 rule will be based on this income.
What if you are self-employed?
If you’re self-employed ensure that you keep aside a certain amount of tax component every month, so at the end of the tax year it’s easy for you to meet tax obligations. Your budget with a 50/30/20 rule will be based on the tax reduced income.
Why is a 50/30/20 Budget Necessary?
There are many reasons why should have a budget
- To start, it will improve your credit score.
- It forms a solid foundation for good money habits
- A structured way to eliminate your debt
- A means to save a deposit for the home loan or to purchase your next expensive item.
Whatever the reason might be having healthy finance and identifying a reason to maintain the habit will motivate you to achieve the goal by budgeting with a 50/30/20 rule.
Current spending habits
How many times have you looked at your bank and wondered where all the money has gone. The only way to understand all the holes in your money bucket is by tracking it. Go back in time and dig out all those credit card statements, receipts, and bank statements. This is a good place to start and understand where the money is spent, you may not be able to tally up your income to the expense but this is a good start.
The information that you have now will equip you with budgeting using the 50-3-20 rule. There might be some wants the can cut down or you might be able to find a less expensive alternative to some of your needs.
Always start with big-ticket items both in needs and wants, talk to your partner, or research more to reduce the cost of these items.
The 50/30/20 rule is a zero-sum game, where every dollar goes to work either by paying your bill or into your savings account earning income.
This is not a golden ratio that is set in stone, your aim here is to increase your 20% gradually as you progress with your budget from year on year.
Also as your income grows you may not really need 50% of your income on essentials. i.e a person earning $5000 per month will find it hard to contain essential expenses within 50%.
That is why I say that the ratio is not set in stone as it depends from person to person, you may be at a point where you spend 80% on essentials and 20% on wants, in that case, you need to start with 1% savings and try to grow this gradually.
So what are essentials or needs, how do you know?
To differentiate between a need and want let’s follow a simple rule.
“Will your life stop….. by not budgeting money to this category will you survive”
Needs are the bills that you must pay for your life to progress, they are a must. Including bills like mortgage, electricity, insurance, etc.
Your total allocated money in your budget should be a maximum of 50%. If you are spending more than 50% on your needs then its time for you to look for a cheaper alternative that can fit in your budget or you may even have to reduce the money you can budget to wants category.
Be mindful that a need can easily be turned into a want, having a car is a necessity but which car to buy can make it a want.
Is having a Netflix connection a need or a want?
This is where we get into our next chunk of the pie.
Wants are where your money gives you that extra comfort and reason to smile some times. This is where you spend money that is absolutely not essential or not required. By not budgeting money to wants, you might feel your life is a drag but you will survive.
This is where you budget money on movies, dining out, travel, and entertainment.
This is the most important segment compared to the above two categories. The whole purpose of following this rule for budgeting is to increase your savings or repay more towards your loan payment.
Let’s look at an example of budgeting with the 50/30/20 rule.
For instance, if you are earning $5000 income per month, then you can.
- Budget $2500 (50%) to meet your needs.
- Budget $1500 (30%) for your wants.
- Budget $1000 (20%) to your savings or for debt repayment.
What’s if $2500 budget is not enough to pay rent, bills and other expenses?
This is where you reduce your budget allocation in wants to meet your needs.
Remember your primary aim is to increase the amount you save, that is by either being smart with your needs or reducing wants.