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A decent budget ensures that you pay your bills on time — and nothing more. But a successful budget means you have a grasp on what you’re spending your money on and what you’re saving for.
The 50/30/20 budget is a popular option to make that happen.
Senator Elizabeth Warren of Massachusetts, a bankruptcy expert who taught at Harvard, originally coined the term “50/30/20 budget” in a book she wrote with her daughter, Amelia Warren Tyagi, titled “All Your Worth: The Ultimate Lifetime Money Plan.”
The budget is similar in premise to other percentage-based budgets: You set aside 50 percent of your income for your needs, 30 percent for your wants and 20 percent for your savings.
Before sitting down with a frighteningly blank Excel sheet to map out your budget, you need to get a real handle on how much money you have to play with. Get your hands on your most recent pay stubs (or if you have direct deposit with your employer, just log into your bank account and see how much you take home each month).
The magic number is your post-tax income: You should budget with a monthly income that has already taken out taxes, Medicare and Social Security. However, if you contribute to an HSA or a retirement account and if health care premiums come out of your paycheck, add those back into your total. You’ll deal with those later.
Things are a little fuzzier if you’re self-employed — I say this as a freelance writer who tries his hardest to budget. The income that you use for your budget should be your gross income, sans all business expenses and the money you set aside for quarterly estimated taxes. Though everyone’s taxes will vary slightly, I set aside 35 percent into a separate account so I’m always covered.
Once you know your actual post-tax income, you can begin to design your 50/30/20 budget. For the purpose of this article, let’s assume you have a monthly post-tax income of $4,000.
Your needs are monthly expenses that you have to pay to survive — or reasonably exist in today’s society.
Common expenses in this category include housing, car payments, insurance (remember, we added health insurance costs to your monthly take-home pay so we could apply them here), grocery bills, utilities, internet, cell phone and outstanding loans (the minimum payment on your credit card or student loans, for example).
The 50/30/20 budget rule states that you should devote 50 percent of your income to this category. Let’s assume you, with your $4,000 income, have the following expenses:
That amount totals $1,870. But per the 50/30/20 budget, you can spend up to $2,000 (50 percent of $4,000) on needs. The remaining $130 could be set aside for unexpected needs, such as vehicle maintenance, a trip to the doctor or new work clothes.
Nobody likes paying for things like rent or groceries, but these expenses are unavoidable. Wants, on the other hand, are the things that keep life exciting and make your hard work worth the effort. And with the 50/30/20 budget, you can spend your money on these things without feeling guilty — up to a point.
Whether it’s beer money, gifts for family members, a new board game, a cup of coffee or a weekend trip to the mountains, your budget allows you to spend up to 30 percent of your income on things you want, no matter how needless they may be. In the $4,000 monthly post-tax income scenario, you can spend $1,200 on your wants.
The final 20 percent of your monthly income should go toward your financial security. This means savings, as well as debt repayments.
Typical savings include contributions to an emergency fund or savings account, and investments in your retirement with 401(k) or IRA contributions (remember, we added these to your income so we could apply them here). Some budgeters might have specific savings goals, like a European vacation or down payment on a house — these savings should also come from this 20 percent.
But this amount is also responsible for your debts. While the minimum payment on your credit card is considered a must-pay and comes out of the “50 percent needs” category, any additional payments (like paying it off in full each month) come from this 20 percent. If you pay extra toward the principle on your mortgage or car payment, this 20 percent also applies.
In the $4,000 example, you would have $800 a month to budget toward savings.
The beauty of a percentage-based budget is that you can adjust based on your needs and goals. The 50/30/20 allocation works for most people, but not everyone.
Maybe you’re fine cutting back on the wants because you enjoy Netflix-binging while dining on ramen noodles, all in an effort to save more money for a month-long vacation and repay credit card debts. For you, a different percentage breakdown might work better.
That said, financial experts urge you to make 50 percent a maximum for needs, if at all possible. This may mean cutting back on grocery expenses, getting a roommate or downgrading to an older-model car.
The most important advice for any budget is to keep up with it. If your savings goals change, if you get a raise or if your utility bills go up in the winter, you need to tweak your budget to ensure your spending and saving habits are in line with the money you make and the bills you have to pay.
Timothy Moore is an editor and freelance writer who covers personal finance, automotive, careers, and other topics. His budgeting practices have helped him buy and renovate a home, travel the world and take care of two very needy rescue pups, all before the age of 30. He currently lives in Ohio with his partner.
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