A budget is a plan that you create for your money, setting up a framework for ongoing spending and saving for your financial goals. Some budgeting methods are rigid, very detailed plans like “cash only”, “envelopes” and strict line item budgets for people who want to plan for every dollar spent and not leave anything in doubt. There are other more flexible methods where money is spent within certain broad categories, such as the 50/30/20 budget . The 50/30/20 rule is intended to shift budgeting from obsessing over every penny to using proportional guidelines that help keep you on track with your saving and spending goals over time. BrightDime, along with many other financial experts are proponents of this budgeting method due to its flexibility and ease of use. The way it works is pretty simple.
The 50/30/20 budget starts with your after tax income and then assigns 50% to needs, 30% to wants, and 20% to savings/debt repayment.
Needs (50%) are things that would severely impact your life if you didn’t pay them.
Housing costs, groceries, utilities, health insurance, auto/transportation expenses are the most common examples of needs. This category also includes minimum payment on certain debts such as credit cards due to the negative impact on your credit score if you didn’t pay them.
A want (30%) is any payment you can forgo with only minor inconvenience.
Cable tv, eating out at restaurants, gym membership and new clothes would generally go into the “want” category. It can be hard to differentiate between a need and a want; you can read more about the difference here.
The last portion (20%) is for your monthly savings.
Think of this category as money you are putting towards the future; like contributions to your 401(k), a savings account, contributions to investment accounts, and debt repayment above the minimums (accounted for in “needs”) including extra payments you make on your home or car and credit card payments above the minimum.
The 50/30/20 plan can be used whether you are just starting out or nearing the end of your career. The categories might seem a little tricky for some items, but they should make sense once you get going and get used to how it works. And remember, the 50/30/20 percentages are guidelines that serve as fence posts, adjusted as needed for your particular situation. You may want to allocate more than 20% to debt repayment if you’ve got a large amount of debt and need to make a dent in it now before it gets out of hand. Or you may live somewhere with high housing costs that bumps your “needs” to over 50%.
If you’re ready to give it a try, here are some steps to help get you started.
Step 1: Determine your after tax income.
Take your gross paycheck and subtract out all federal, state and local taxes (you should see this already done on your monthly paycheck). Add back in any deduction for healthcare, retirement or other benefit deductions as these will be allocated to their appropriate categories. The result is your after tax income.
Step 2. Multiply the after-tax income by 50%, 30% and 20%.
This will give you the amount to use as a guideline for each of the budget categories (50% needs, 30% wants, 20% savings/debt repayment).
Example: If your after tax income is $4,000, you would allocate $2,000 to needs (50%), $1,200 to wants (30%) and $800 (20%) to savings/debt repayment.
Step 3: Review your spending.
Include payments (cash, debit, credit cards, venmo, etc), savings, and any other deductions (health, 401(k)). Don’t forget to include any payments you may make annually (property taxes, insurance, etc). Determine if each outgoing payment are needs, wants, or saving/debt repayment per the summary below and then total each category.
|Category||% of Income||Examples|
|Needs||50%||Mortgage, rent, groceries, bills/utilities, auto, health care/medical insurance, minimum debt payments , child care, necessary clothing, household costs (insurance/ maintenance)|
|Wants||30%||Shopping, dining out, cell phone, cable, online services, travel, entertainment, gifts, donations, personal care, pets|
|Savings / Debt Payments||20%||401(k), investments, savings accounts, debt payments above the minimum, extra principal payments|
Step 4. Compare each total from Step 2 to each total in Step 3.
The amounts in step 2 are your targets, and the amounts in step 3 are what you’re actually spending in each category. How does the comparison look? Are they close or way off?
Step 5: Check in every few months to see how you are doing.
Remember, the percentages are just guidelines so adjust as needed. If you have big goals for the future you may want more than 20% going to savings. You’ll have to shift that from another category but that’s ok, the 50/30/20 amounts are just a starting point. Your budget is a reflection of your priorities so make it your own!