Budgeting is often seen as the ultimate sign of “adulting”, but we’re here to show you that it doesn’t have to be as complicated as it seems.
For many people, budgeting is a thing they think they will set up when they have a spare half hour to properly sit down and work things out. They think it will take a lot of time and a lot of brainpower. And then life gets in the way – as it is wont to do – and before you know it, a year’s gone by and you still have no budget in place and don’t really know what you’re doing with your finances.
The good news is that setting up your first budget really doesn’t have to be complicated. Whilst there are many options out there, if you’re looking for a straight-forward budgeting method that is easy to implement, look no further. The 50-30-20 method is a great way of understanding budgets. It’s especially good for newcomers to budgeting, people who want to change their financial habits, but are not sure where to start or how much they should be saving each month.
What is the 50-30-20 method?
As a budgeting method, it’s one of the more self-explanatory methods out there. It’s all in the name. Essentially, your budget is split into three distinct categories: living expenses, wants or lifestyle choices, and savings. Following the 50-30-20 method means that every month (you might have guessed it):
- 50 percent of your income is spent on living expenses (rent, mortgage, bills, groceries, transportation, etc.).
- 30 percent of your income goes towards “wants” (the things you do for fun, like entertainment, eating out, or the gym).
- 20 percent of your income goes into your savings or towards paying debts.
For example, let’s use some nice round numbers and say you earn $2,500 a month (after tax). Using the 50-30-20 method it’s divided so that…
- $1,250 is dedicated to your living expenses
- $750 goes towards discretionary purchases (anything you want to spend your money on)
- And $500 is put into your savings or towards paying your debts
The method was coined by Senator Elizabeth Warren and her daughter Amelia Warren Tyagi in their co-authored book All Your Worth: The Ultimate Lifetime Money Plan and is reportedly a method she used when teaching about bankruptcy before she became a politician. It’s an easy way to start saving, especially if you’ve never set up your own budget before.
TIP! Take your money further, faster. AXOS Bank is an online-only bank offering higher yield savings than traditional banks, in fact, 8x the national average APY. No minimum balance requirements. The opening deposit is $250.
How can it help?
The 50-30-20 budgeting method is a great way to start your budgeting journey.
It’s an easy to understand method, splitting your costs into three basic categories. However, the biggest benefit is that it’s not strict. Whilst it’s called the 50-30-20 method, you can adapt it to suit your situation, whilst maintaining control over your finances.
Lots of budgeting methods don’t take human error or “wants” into account, but the 50-30-20 method provides a discretionary budget, meaning you have financial control and a “fun” budget; instead of focusing simply on ensuring you can cover living costs and create savings, this method allocates money to spend on the things you want in life. With this budgeting method, you know exactly where your money is going and don’t lose out on anything you want, but don’t necessarily need.
TIP! Follow this budgeting course and learn how to save money by taking control of your spending. Find and eliminate excess spending in your existing budgets.
Of course, nothing is ever perfect
There are, as with all budgeting methods, a couple of drawbacks that are worth mentioning.
The first and most obvious problem with this is its vagueness. In theory, the three categories may sound like they cover everything, but it’s inevitable that you’ll come across certain things that you might want to count as a living expense when in reality it is a lifestyle choice. For example, clothes are a necessity but anything past the basic pieces crosses over into a lifestyle choice. You might be tempted to count a new pair of trainers as a living expense – after all, you need trainers in order to go to the gym – but it’s important to recognize where something stops being needed in order to live and starts being a choice you have made. The 50-30-20 budgeting method can make it easy to hide bad spending habits; it’s important to make sure you question your own spending and hold yourself accountable.
Another negative is that this method puts savings in last place. 20 percent isn’t a lot of money if you’re trying to pay off debts and save money. For some people, this 20 percent may only just cover a debt, which means you’re not actually saving anything. It’s important to always have some kind of savings, not just because you likely want to retire someday, but also because you never know when you might have to handle an unexpected expense.
On the other hand, if you’re a high earner, you may be saving less than you should. For those with a high income, the idea of spending 30 percent of that on the “fun” parts of life might sound great, but could that money be put to better use? Just because you can spend the money on the things you want, doesn’t mean you have to.
It also doesn’t favour paying off debts quickly. Due to the fact the 20 percent is split between saving money and paying off debts, you may need to negotiate how this works for you. Do you split it so each has an even 10 percent? Or do you pay off as much of your debts as you every month?
Think of it as a starting point
It might have its drawbacks, however, the 50-30-20 method doesn’t have to be super strict in order to be beneficial. Your wants and needs are going to change as your life does, so your budgeting needs to reflect this.
If there are times that saving 20 percent doesn’t seem plausible, that’s fine. If there are months that you can save more than 20 percent (either because you have a larger income or because you don’t use all the money assigned elsewhere) that’s great!
Budgeting is a personal thing, so it’s about making your money work for you.
TIP! Join Honey, the money-saving app. Honey automatically finds the best coupon codes while you shop online. On average, their 17 million users save $115 on their online shopping every year. Best of all, it’s free.
Why 20 percent?
The real question here is: what are you saving for?
For most people, the answer is the day we no longer need to work: we’re saving for our retirement. In order to enjoy that period of your life, you have to save when you’re young.
A report by the Stanford Center on Longevity in 2018, determined that you should set aside 10-17% of your income in order to retire by 65 years old. And that’s if you start saving by 25. If you start later than that, it makes sense that you have to save more to compensate for the years you weren’t saving.
How much you save and how you save it are all affected by the lifestyle you want to live – both now and in the future. The benefit of the 50-30-20 method is that you’ve set your budget for discretionary purchases, 30 percent of your budget is dedicated to your lifestyle, so you’re saving 20 percent to ensure that you can maintain that lifestyle in the future.
TIP! Use the free, powerful financial planning tools from Personal Capital to take control of your financial life and get objective advice from their fiduciary financial advisors.
What if I can’t save 20 percent?
As I mentioned earlier, budgeting is personal. Not everyone can afford to save 20% of their income every month. If that’s the case, start smaller. Work out how much you can save every month – and be realistic about it. If starting to save means you need to cut back on your discretionary budget, then you have to evaluate your priorities.
This does not mean you should start feeling guilty every time you eat out because that money could be going towards your savings – that’s a privileged way to be thinking and you shouldn’t stop enjoying life just so that you can follow a budget created by somebody else.
Instead, evaluate where you want your money to go. Make the budget work for you.
If you can only save 1 percent, save 1 percent. If this works for a while, try increasing it to 2 percent, or 3 percent. Maybe you jump to 5 percent and things are still working out just fine.
If you reach 10 percent and it’s too much for your finances to handle, just scale it back! There’s no harm in changing the percent you are saving to match your circumstances, whether they change for the better or for the worse. Budgeting is there to help you understand your finances, it’s not a strict guideline: your plan can change depending on what’s going on in your life.
TIP! Sign up to Truebill. Their app makes it easy to optimize your spending, manage subscriptions, lower your bills, and stay on top of your financial life.
401(k) or pension contributions are savings
An important note to make is that 401(k) or pension contributions can absolutely count as a part of your savings – and so can any contribution by your employer. Taking the example from earlier, if you make $,2500 a month (after tax), your savings goal is $500.
If you make a five percent contribution to your pension every month, that’s $125. If your employer matches this, that means you’re putting $250 into your pension plan (and therefore your savings) every month. This definitely counts as the savings section of the 50-30-20 plan.
At this point, you still owe your savings $250; you can save it in whatever way suits you best. Remember, the important thing is always that you’re saving the money, no matter how you’re doing it.
I’ve reached 20 percent, now what?
Keep going!
Whether that means continuing to increase the amount you’re saving or sticking with the 20 percent, you’ve now got yourself a functional budget that works for you. Congratulations!
The point of the 50-30-20 budget is that this division of your income allows for living the lifestyle you want now, whilst putting some aside for the future. It’s up to you how the 20 percent is split between paying off debts and saving money, so make sure you check in occasionally to ensure it’s still working for you. That way you can adjust your budgeting as your situation changes. There are loads of budgeting methods out there to help you save money and plan your finances. At the end of the day, it’s about finding a system that works for you; you need something that makes the most of the money you have coming in, supports your lifestyle, and, most importantly, a method that you can stick to. The 50-30-20 budgeting method is a great way to begin to understand your finances, start saving for your future, and ensure you know where your money is going each month.
