Many people don’t realize that the 50/30/20 budget was created by none other than the 2020 Democratic presidential candidate and Massachusetts Senator Elizabeth Warren.
In her New York Times bestseller, All Your Worth: The Ultimate Lifetime Money Plan, Warren offered a new way of thinking about money management that helps you on your path towards financial well-being.
In her view, you’re working hard to save money, so why is there never enough to overall the bills, to put some away in your child’s college fund, to pay off your credit card debt – or to relax and have some fun, for once?
Resulting in more than twenty years of research, her radical plan could help you master your finances – for the rest of your life.
Ultimately, no two situations are ever the same, so take the advice below with a grain of salt and try to adapt it to suit your own needs. There are no hard and fast rules to budgeting, so it’s always worth exploring new ideas and ways of thinking.
What is the 50/30/20 Budget?
Instead of keeping track of every penny you spend, the 50/30/20 budget helps you simplify your saving goals. The 50/30/20 budgeting strategy splits your income into three main categories: the things you need, the things you want, and a savings fund. We allocate 50% for needs, 30% for wants, 20% for savings, or paying off debt. Distributing your spending into three distinct categories could help prevent you from overspending without using too much mental energy to keep track of progress. You’ll save a lot of time and stress from keeping track of every penny that comes in and out of your account, and it’ll help you stay on track to reach your financial goals.
The 50/30/20 Budget in Detail
Understanding the 50/30/20 budget is simple. You divide your after-tax income into just three spending categories – needs, wants, savings, or debts.
Understanding your spending limits for each category makes it a lot easier to stick to your budget and keep your spending in check. Here’s what a budget looks like when you apply the 50/30/20 budget:
Spend 50% of your money on needs
The “needs” are the actual payments you cant avoid or would be difficult to live without. According to the budgeting rule, 50% of your after-tax income should be allocated to cover your most essential expenses. There is a caveat here, though, and one we will discuss in detail later on. If you’re in a low or high-income bracket, allocating 50% towards your “needs” is either impossible to do or completely irresponsible. I advise you to take the “50%” rule and adapt it to suit your particular situation. Now, let’s discuss what we include in our “needs” section:
- Electricity and gas bills
Let’s say your after-tax income is $4,000. For this example, $2,000 should be allocated to spend on your needs. As I mentioned before, no two situations are ever the same. Suppose your total expenses are higher than fifty percent of your take-home income. In that case, Warren suggests finding ways to increase your revenue, swapping to different energy providers or savings money on bills, or looking for a cheaper apartment. If allocating 50% still seems too high or low, you can still experience the benefits of this budgeting strategy by adjusting the percentage to suit your lifestyle.
Use 30% of your money on wants.
Now that we have allocated a percentage of our income towards covering the essentials, it’s time to turn our attention towards our “wants,” which are non-essential expenses that you’d like to have but could live without if you had to.
According to the budgeting rule, you should allocate 30% of your after-tax income to cover your wants.
- Eating out
- Shopping for clothes
- Going on holidays
- Gym Memberships
- Media subscriptions (Netflix, HBO, Amazon Prime)
- Groceries (other than essentials)
Using a similar example, if your monthly after-tax income is $4,000, you can spend $1,2000 on your wants. If you feel like that amount is too much, you could always cut back or reallocate the money to a different category.
Following this budgeting strategy shouldn’t prevent you from doing the things you love doing in life. It simply helps you be more responsible with your money by finding areas where you could be spending too much. If you’re wondering whether an expense is a “need” or a want,” ask yourself, “Could I live without this?”. If yes, it’s probably a “want” and not a “need.”
Save the remaining 20%
You’ve allocated 80% of your income towards a budget that helps you cover the things you need and want, and now it’s time to put the remaining 20% towards achieving your savings goals, paying back any outstanding debts, or investing.
By consistently putting aside 20% towards an emergency fund, personal financial plan, down payment on a house or investment account, you’ll end up with a system that’ll help you build a financially healthier future.
If you bring home $4,000 after tax each month, you could put $800 towards your savings or investing targets. Within a year, you’ll have saved close to $8,400, and let’s not even get into compounding interest!
A step-by-step guide to applying the 50/30/20 Budget
Ok, so we’ve talked a lot about the 50/30/20 budgeting strategy in theory. But how do I use this Rule to my advantage? To put this simple Rule into action, you’ll have to calculate the 50/30/20 ratio based on your income. Here’s a three-step process to help you get started with the 50/30/20 budget:
1. Calculate your income after taxes.
Your first step is to calculate your income after tax. Look at your paycheck to see how much money is deposited into your account each month. If payments like health insurance or pension funds are automatically deducted, make sure you add them back in.
If, like many people, you work as a freelancer in the gig economy, subtract your expenses and tax to arrive at your actual income figure.
2. Categorize your expenses
Understanding where your money goes every month, it’ll help to categorize your expenses. Download your bank statements and manually categorize your last 30 days of expenses, or you could download an app that could automatically do it for you instead. After getting a clear picture of where your money is going, split your expenses into the three categories we discussed earlier: needs, wants, and savings. Remember, needs are essential expenses you can’t live without. Wants are things you’d like to have but could do without, and savings are money you’ll allocate towards an emergency fund, loan repayments, or investment accounts.
3. Monitor and Adjust your spending to match the 50/30/20 Budget
Now that you have a clear idea of where your money is going, you can begin making adjustments to fit the 50/30/20 budget strategy. Cutting back on needs can be challenging, so perhaps start with reassessing your wants.
Many people end up overspending on things they don’t need, so it can be helpful to ask yourself the following question: Can I live without it?
The more you cut back on your wants, the more likely it is that you’ll be able to hit your savings and investing targets. Although it’s important to note that you shouldn’t deprive yourself of things you enjoy doing, like with weight loss, you have to create a system that’s sustainable in the long term to achieve the best results.
Why the 50/30/20 Budgeting Strategy Works
One of the great things about the 50/30/20 Rule is how easy it is to implement. It’s a minimalist budget that has the potential to pack significant benefits. Here are a few reasons why we think you should consider it:
- It’s hard to improve your saving and investing goals if you don’t know how much or where you’re spending. It may seem pretty obvious, but it’s also vital. Categorizing your expenses and adjusting them to fit the 50/30/20 budget is an excellent way to set a baseline and figure out where you’re at from a savings perspective.
- The 50/30/20 Budget can highlight opportunities to reduce unnecessary expenses. Our spending can quickly get out of hand, and the simple act of categorizing your costs can be enough to help push you in the right direction and start making adjustments.
- By using this method, you’ll find that it helps reduce stress and adds clarity to your spending. Instead of constantly worrying about every purchase, rough boundaries can help ensure you stay on track without counting every penny.
- The 50/30/20 budget can be simpler and easier to maintain than other budgets that track many more categories.
Problems With The 50/30/20 Budget
It’s essential to take the 50/30/20 budget with a grain of salt. Not everyone can benefit from using this type of Budget, and it’s vital to assess the pros and cons of every strategy before implementing it. Here are a few issues with the 50/30/20 Rule and why it may not be a good fit for you:
1. Difficulties with Categorizing Spending
It’s not easy to categorize all of your expenses into three distinct sections. There are many gray areas when it comes to defining something as a want or a need. For example, many groceries may fall into the wants categories because you can technically live without them, but you may not feel like giving them up.
2. Low-income people need to allocate more than 50% for needs.
For many low-income households, especially those living in expensive cities, spending as little as 50% of their after-tax earnings on needs could be impossible. You could try shopping around for cheaper housing or negotiating better rates on bills, but you can only do so much. You’ve probably already trimmed your Budget as far as you can, and going any further may not seem like an option.
3. It Encourages Wasteful Spending
If you’re making $20,000 a month, under the 50/30/20 Rule, you can spend up to $6,000 on whatever you want. Fancy dinners and extravagant holidays, anyone? Sign me up! Well, if you’re following the 50/30/20 Budget, that’s precisely what they suggest. However, hopefully, you wouldn’t do this because it could cause high-income individuals to spend a lot of money on things they don’t need instead of setting it aside for savings or investments.
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