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Like many, you might 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. It involves 3 easy steps that will help you prioritize your monthly financial commitments. Also known as the 50-30-20 rule, 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.
In this article, we will explore the 50-30-20 budget. What it is, how it works and we'll also explore a great 50-30-20 budget calculator that you can start using immediately.
Ready? Let's jump right in!
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
- 30% to wants
- 20% to savings
This plan keeps your finances simple and easy to follow.
How did the 50-30-20 budget start?
U.S. Senator, Elizabeth Warren, came up with the 50-30-20 budget. In a book called All Your Worth: The Ultimate Lifetime Money Plan, Senator Warren described this simple way to budget. Not surprisingly, it has stuck. People love how easy it is to understand and to follow!
Why the 50-30-20 rule works
You might be wondering why this budget works. There are a few reasons.
Firstly, the budget is really simple. If you're not into details or if you're just starting out, this budget is fail-safe and easy to implement. 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 dollar. 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.
Lastly, it can help you save up for large expenses such as a house or car or it can help you pay down debt.
How to use the 50-30-20 rule to create your budget
The 50-30-20 budget rule is very simple. To get started, you need to figure out your after-tax income. After-tax income is simply the amount of money you have leftover after taxes are removed. These taxes include federal, state, medicare, and social security. If you want a quick and easy way to figure out your take-home pay, simply look at your pay stubs.
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 state and federal taxes.
Once you've figured out your after-tax income, the fun begins. You can now split your income into the 3 categories.
Category 1: 50% Needs
The first category is for all your basic needs. This includes things you simply cannot live without. You can include rent or house payments, health insurance, food, car payments, utilities, and debt payments. As you can see, the needs only include items you need to survive. Do not include entertainment, take out or fine dining in this category.
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. Are you paying too much in rent? Are you spending more on transport than you can afford? Do you spend a large chunk of money on week-day lunches?
Whatever the case, you can make immediate changes to your spending that will bring costs down. You can move to a more affordable home or you can start using public transport to keep costs down. Additionally, you can make lunch at home to bring it to the office.
Category 2: 30% Wants
Wants are all the "nice to haves" that you spend money on. These are items you don't need in any way. 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 purchase, there is almost always a cheaper alternative. With that said, it is important to balance your wants vs. needs so that from time to time you get to enjoy some of these activities. However, exercise wisdom and good sense. The wants category tends to be the trickiest to master.
For some, wants may include premium experiences that are beyond reach financially. For example, someone may want a new BMW when they can easily have a Toyota that would cost much less. Exercise wisdom with your wants as it can be easy to justify spending if you really want something.
Category 3: 20% Savings
Arguably the most important category for your future is the savings category. Savings in this case refers to both savings and investments. Savings can take many forms ranging from your emergency fund to your savings account. They can also include any money market investments that you have.
Investments refer to any money you have set aside to generate income. This can include investing in the stock market, purchasing real estate, or setting up your retirement accounts.
Your top priority in this category should be your emergency fund. It is important to have three to six month's worth of living expenses saved in your emergency fund.
Lastly, 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.
Using a 50-30-20 budget calculator
Figuring out your 50-30-20 budget does not have to be difficult. In fact, it can be as easy as using a simple budget calculator.
Here is a 50-30-20 budget calculator developed by Banzai together with Shinhan Bank. All you have to do is enter your post-tax income and it does the rest for you! You'll be able to easily see how much to allocate to each of the 3 categories.
In conclusion, 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. Remember to use your post-tax income as your base and make further calculations from there. Now that you have all the steps in place, go ahead and get started today!