Do you shudder at the word budget. Rightly so. For years, budgeting has been painted as a challenging task. However, nothing could be further from the truth. A budget is simply a plan for how you will use your money. There are many budgets out there that can work for different needs and lifestyles. And they don’t have to be difficult.
If you’re looking to simplify your budgeting process, or if you’re new to budgeting, the 50-30-20 budget might be the perfect match. The 50/30/20 rule budget only requires you to track and divide your expenses into three main categories: needs, wants, and savings or debt. This budgeting method is comprehensive and covers all the bases. Also, if you shy away from doing the math, there are many calculators out there that can help you with this method.
What is a 50-30-20 budget?
In its simplest form, the 50-30-20 budget rule divides your after-tax income into three distinct buckets. These buckets are:
50% to needs (rent, mortgage, groceries, bills transportation, etc.)
30% to wants (fun and entertainment, dining out)
20% to savings
This plan keeps your finances simple and easy to follow.
How did the 50-30-20 budget start?
Harvard bankruptcy expert Elizabeth Warren—U.S. Senator from Massachusetts and named by TIME magazine as one of the 100 Most Influential People in the World in 2010—coined the “50/30/20 rule” for spending and saving with her daughter, Amelia Warren Tyagi. They co-authored a book on it in 2005 called “All Your Worth: The Ultimate Lifetime Money Plan.”
So how does the 50/30/20 plan work? Here’s how Elizabeth and Amelia recommend you organize your budget.
Why does the 50-30-20 rule work?
Firstly, the budget is really simple. If you’re not into details or if you’re starting out, this budget is fail-safe and easy to put in place. With it, you only focus on 3 buckets – needs, wants and savings and they are pretty easy to figure out. You don’t have to spend time figuring out specific categories for your finances.
Secondly, it helps you account for every rand. You start off with your after-tax income which represents 100% of what you have to work with. And then you work out the different categories from there.
How to use the 50-30-20 rule to create your budget
Calculate Your After-Tax Income
Your after-tax income is what remains of your paycheck after taxes are deducted. Basically your take home pay. If you’re an employee with a steady paycheck, your after-tax income should be easy to figure out if you just look at your pay-slip.
If, on the other hand, you run your own business, you can still calculate your after-tax income. Take your gross income and subtract your business expenses and any taxes.
Once you’ve figured out your after-tax income, the fun begins. You can now split your income into the 3 categories.
Needs are expenses that you absolutely must keep in your budget no matter what. These include things like housing, utilities, transportation and health care expenses. And at least the minimum payments on your debts . As you can see, the needs only include items you need to survive.
You should be able to comfortably meet your needs with 50% of your after-tax income. If you are spending more than this, you may want to re-evaluate. Then make immediate changes to your spending that will bring costs down.
Wants are expenses that you choose to spend your money on but that you don’t need to live your life. They are the “nice to haves” that you spend money on. Wants include things such as going out to the movies, eating out, new electronic gadgets, new handbags, and shoes, or tickets to a big game.
There are many good substitutes for wants that cost little to nothing. For example, you might want to buy the latest iPhone but you can buy an earlier version and still get the same benefits. You might want to sign up for the gym but could work out at home instead.
With almost any item you want to buy, there is almost always a cheaper alternative. But, it is important to balance your wants vs. needs so that from time to time you get to enjoy some of these activities.
20% on Savings and Debt Repayments
The savings or debt category is money you set aside for your future or to pay off debt faster than required. You can use this money to build an emergency fund, save for a down payment on a home, and invest for retirement.
If you want to save money more quickly, you’ll need to set aside some of your wants money for extra savings.
Your top priority in this category should be your emergency fund. and your rainy day funds. It is important to have three to six month’s worth of living expenses saved in your rainy day fund.
Debt repayment also falls into the savings category. You might be wondering how as we had included debt payment in the “needs” category. Any payments you make to cover the minimum requirements fit into the “needs” category.
Additional payments towards interest and principal are considered savings. This is because they are “saving you” from future interest payments down the road.
14 Day Financial Detox Challenge
A financial detox is the process of giving your wallet some room to breathe. It’s pressing reset on your spending habits. And it’s being more intentional about how you view and relate to money
Is the 50/30/20 rule budget good for you?
The 50/30/20 rule can be a sound budgeting method for some people. But whether the system is right for you depends on your specific circumstances.
Having just three categories to track might help you focus on fine-tuning your finances instead of getting bogged down in the process of categorizing each individual expense. For others, the lack of structure could make it harder to find ways to improve their spending habits. Ultimately, you need to decide whether a budgeting system that’s less detailed or more highly detailed will be best for you.
Another potential issue with the 50/30/20 rule budget is the breakdown of money allocated to needs, wants, and savings or debt. Depending on your income and where you live, 50% may not be a large enough percentage to cover your needs.
For instance, people who live in areas with a high cost of living may have to put a large part of their income toward housing. Making it almost impossible for them to keep their needs under 50% of after-tax pay.
Some say the 50/30/20 rule budget doesn’t work well for higher-income earners, because it calls for too much spending on wants versus needs or savings and debt.
Budgeting does not have to be difficult. The 50-30-20 budget can be a great way to get your feet wet in the world of budgeting. It can help you achieve your budget goals in a quick and easy way.
Keep in mind, you can adjust the rule for your particular needs by changing the percentages to match your personal situation and financial goals. If that doesn’t work, there are plenty of other budgets you can try, too.