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Learning effective budgeting can be tedious, especially when you’re starting your first budget. There is a budgeting method out there that will work for you. One such budgeting method that many people start with is the 50 30 20 budget rule. Let’s learn more about how to budget better by using this method.
Why 50-30-20 Budgeting Method Works
The average American saves less than 10 percent of their income. So this method is very useful for those who are learning how to budget for the first time. This simple budgeting rule can help you find ways to save more and double the amount you save.
There are only three categories to keep track of which makes it much easier to start budgeting. Plus it will help put in perspective how long it will take to reach a certain goal. For example, if you wanted to save $5,000 for a down payment on a new car, you could put away $600 a month on a $3,000 salary. It will take you a little over eight months to save enough for a new car’s down payment. That’s not factoring in whether or not you have other financial goals you want to work on at the same time.
Enjoy the Budget Planning Process
Setting up a realistic budget that considers all your various expenses will go a long way to help you succeed. People start budgeting for a variety of reasons. Here are some popular reasons how people use a budget planning process to help them keep on budgeting track:
- Break out of the paycheck to paycheck cycle
- Reduce debt
- Cut their spending habits
- Start an emergency savings fund
- Save up for a big goal like buying a house, car, or taking a vacation
Choosing a Budgeting Method
Using a budgeting method like the 50 30 20 will help to build budgeting habits. It uses a flexible budgeting method that reduces the time you spend keeping track of your finances. This budgeting rule allows you to focus on the big picture instead. The 50 30 20 rule’s streamlined approach makes it easier for people to start managing their finances more effectively.
Adopting a budgeting method to use will show you how you will achieve your financial goal. Think of your financial goal or reason for budgeting as your destination. The budget is the car that will help get you there. No matter what type of budget you choose, make sure to use a tracking method that fits well with you. That could mean jotting things down on a notebook that you keep with you, using an Excel spreadsheet, or downloading an app for budgeting. The important thing is it’s a tool that you can use effectively.
How to Use the 50 30 20 Budget Rule
Senator Elizabeth Warren popularized this budgeting method from her book entitled “All Your Worth: The Ultimate Lifetime Money Plan”. The 50 30 20 budgeting rule is very straightforward and simple to calculate. You take your monthly take-home income and divide it into three budgeting percentages. The rules for saving money are that you have 50 percent for your needs, 30 percent for wants, and 20 percent for savings and debt repayment.
These budgeting percentages can get a little difficult to distinguish between a need and want. So let’s talk about each of these buckets in more detail. Start by paying yourself first, which is usually 50 percent of your income. Think of your needs as the absolute minimum that you need to survive. These are all the necessities that are expenses that can’t be avoided, including:
- Food (groceries)
- Utilities (gas, electric, water, trash)
- Insurance (health, car, home)
- Minimum payments on outstanding loans (amounts that are over this should go in your savings debt repayment allocation)
- Child care and other expenses related to needs that enable you to go to work
The next largest bucket is your wants. These are the extras that you don’t need to work or live. They include the “fun” stuff but also relate to things that reside outside the basic niceties. For example, you need a coat for the winter season. But if you shop for one at retail cost at the mall over heading to the discount outlet, that’s a want. This area is where your Netflix, Starbucks, and Chiptole expenses all go. Other items found here include:
- Eating out
- Monthly Subscriptions
- Clothing and shoes (outside of your basic needs)
- Sporting events
- New electronic gadget
- Personal care including haircuts, spa, and nail care
Your “wants” bucket is anything optional. Instead of a gym membership, you could work out at home or go running outside every morning. You could swap out a family trip to the movie theater or a night-in watching a TV show with store-bought popcorn. For transportation, you could need to have a car. But if you choose a Range Rover when a Toyota Camry suffices, that’s considered an upgrade.
Lastly is the 20 percent of your income that goes into your savings and debt. It is where you find money to use for your future goals or paying down existing debt. It will depend on your situation, but common items include:
- Building an emergency fund
- Paying off credit cards or other high-interest debt
- Saving for retirement
- Vacation fund
- Down Payment for a home or car
Let’s look at an example of how this method could look. Let’s say that your monthly income is $5,000. Using this budgeting method, you would have $2,500 to spend on your living expenses and other needs, $1,500 on wants, and $1,000 on saving or debt obligations. Pretty simple right? It’s a great option, especially for people who are new to budgeting and want to start this valuable habit.
How to Budget Better?
To become more effective budgeting with the 50 30 20 rule, consider taking a deeper dive into your current spending habits. Review your bank and credit card statements to look for areas that you are overspending. Do you spend a lot of money on shoes or eating out? Make a plan to curtail this spending before you use this budget.
After categorizing your budget into these three types of expenditures, you may find some areas that need improvement. For example, you might discover that you need more than half of your after-tax income to cover your needs. There are a few ways that you could go about solving this. The first is to review your “wants” and find areas that there could be some cuts, such as cooking meals to take for lunch instead of eating out. Or you could downsize your life with a less expensive apartment, renting out a room in your home, etc.
Regardless of the type of budget you choose, the most important part is that you stick to it. Without following the budget, you won’t be able to get the value out of it. One trick you can try with this type of budget is to immediately spend your first monthly paycheck on all your needs and savings. You’ll have what’s leftover that can be spent on your wants, which you don’t necessarily have to spend it all there either.
One of the reasons that the 50 30 20 budget is so popular is that it doesn’t require you to keep detailed records of your spending. Don’t become too distracted if you happen to end up spending more on your wants than intended. You need to follow the budgeting guidelines, but there is also space to be flexible.
Let’s say you live in a city that has a high cost-of-living. You might need to increase your “needs” category to 55% or 60% and lower your “wants” accordingly. Don’t feel like you have to follow this method or any other type of budget with a fine-tooth comb.
Rules for Saving Money
Your reason to start budgeting might be to have an emergency fund and eliminate your credit card debt. So which should you do first with the 50 30 20 rule? You can split it however you like. But if you’re having problems deciding whether to focus on one or split your funds, here are some questions to ask yourself:
- What do I want to achieve in the next year? What about five years?
- What matters to me more right now?
- Do I have a lot of high-interest debt that is getting in my way of becoming debt-free faster?
You may have a lot of financial goals that you want to achieve. Use the framework from this budgeting method against the goals you wish to achieve. The openness of this method shouldn’t get in your way. Build your various goals into this budget instead. It’s ok if that means your saving percentage must increase. After all, the whole purpose of budgeting is to help you achieve your financial goals. Adjust, remove, and add subcategories as necessary to make these rules work.