Budgeting: The 50/30/20 Method
Budgeting is a cornerstone habit of building wealth and gaining financial freedom. One method for budgeting is the 50/30/20 Budget. Before we get started, I wanted to take a second to recap for any new readers.
I recently started on a journey to gain financial strength/independence. I WILL get my finances in order, to give me the freedom to do the things I dream. My first goal is to be able to buy my dream boat!
Secondly, I want to teach and motivate you ALL to do the same! In my opinion, learning from others mistakes can be game changing! So, let’s learn together; let’s motivate each other and kick that debt out of our lives for good!
Idea Behind Budgeting.
Budgeting can be tedious and unexciting. I find that to be true. If you have plenty of bills outstanding, more than available resources it’s a pretty discouraging and upsetting situation. However, this seriously calls for a basic understanding of how to budget.
Operating without a budget is a fast way to go broke because it’s difficult to put money towards items that help meet your long-term and short-term financial goals.
What Is a Budget?
The short and skinny of it; a budget allocates your money towards expenses, savings, and debt repayment. It leaves emotions out of the process. Besides, it guides and controls individuals or household spending.
For the most part, budgets track and project your monthly salary and expenditures. It allows us to know precisely how much we SHOULD spend and in what areas!
Spreadsheets to Use!
Budgeting tools can make creating and maintaining a budget much more manageable.
There are pre-built spreadsheets designed for budgeting. It is incredibly user-friendly and makes almost everything easy. You plug in your most common expenses such as electric bill, cable bill, mortgage, etc., and it will do all the calculations for you.
I have used Excel and Google Sheets for this when researching how I want to set up my budget. Here is one example of what you can find in Google Docs. I tried both so I could pick the best one for my needs. I prefer Google Sheets for this, and the charts give a nice visual to drive the point home a bit better.
A good spreadsheet is CRITICAL to being successful with a budget, no matter which budget technique you use!
The hardest part, in my opinion, is figuring out what your expenses are! If you are anything like me, you may not even know where some of your money goes! I mean, I know my money goes to a plethora of unnecessary things. I know where and when I spend money, but the fact remains that once you look at it all and add it up, you may be amazed by how much you spend!
SIDE NOTE: I am still working on that part. Starting on March 15th, we started keeping every single receipt. We are going to do this until April 15th. At that point, I am going to compile all the data. This information will tell us definitively where our money goes, and where to STOP spending! It will also very likely be slightly depressing to know!
Software to Try Out!
Budgeting software is another valuable tool to use. There are many different ones out there, so I suggest trying a couple of different ones to find the best one for your needs.
I am going to try Personal Capital. It tracks pretty much everything for you. However, I can’t get much more detailed than that as I have yet to get going with it.
A good friend of mine suggested an app called Every Dollar made by Dave Ramsey. I will try this one pretty soon as well to see which is better between these two.
Again, there are plenty more; those are just the two I intend on utilizing to see which one works best for me.
The 50/30/20 Budgeting Method.
This budgeting technique divides your net income into three main categories: essential needs, your wants, and your savings/debt repayment.
Once this is all established, your income will be allocated as follows: 50% on needs, 30% on wants, and 20% on savings/debt repayment.
SIDE NOTE: At first, I plan to swap the wants and savings/debt repayment categories.
This budget is to assist you to spend money the right way. If you follow the budget precisely, it will cut out some unnecessary overspending. It will increase your savings, and it will speed up your debt elimination. To achieve this, you HAVE to stick to your budget.
This budget method is NOT for everyone and will NOT work for everyone. Your circumstances are different than mine, and someone else’s and thus should be the critical consideration. Even if this method doesn’t work for you, please find one that does!
How To Establish the 50/30/20 Method.
STEP 1 – Establish Your Take Home Pay or Net Income.
Just in case that is not clear, you need to know how much money hits your bank account after all taxes and deductions. Your net income is the basis for the 50/30/20 budgeting method.
STEP 2 – Allocate 50% of Your Net Income to Essential Needs.
These are the items that are completely necessary for survival for example:
- Mortgage/homeowners insurance or rent/renters insurance.
- Utilities – water, electricity, natural gas, etc.
- Food – Only groceries in this category! Eating out is a want, not an essential need.
- Transportation – gasoline or bus/train pass if you ride the bus/train to work.
- Contractual obligations – Internet and cell phone bills (these have become the new “necessities”).
SIDE NOTE: If you have excess funds in this category, you should put that towards your emergency fund or debt repayment. If you fall short, make it up from the 30% wants area!
Check out Save Money On Your Food Budget!!
STEP 3 – Allocate 30% of Your Net Income to Your Wants.
These are things such as the following:
- Vacation and dining out
- Gifts (Christmas gifts, birthday gifts and wedding gifts)
- Cable TV
- Hobbies (gym membership or magazine/online subscriptions)
SIDE NOTE: At the end of the month, or even at the end of each pay period if you so choose, put any money left over in this category to an emergency fund or debt repayment. Another good option is to open a savings account for vacation savings. You can place extra funds from this category there, and eventually take an excellent, and much-needed dream vacation!
STEP 4 – Allocate 20% of Your Net Income to Financial Priorities.
This step is quite possibly the most critical of the three categories. It most certainly is for me! This category will set us up for financial success and allow us to get rid of our debt for good!
This category can consist of many things, for example:
- Savings for an emergency. Emergencies are inevitable, and you can’t ignore them.
- Retirement savings.
- Down payment for a house fund.
- Debt repayment (student loans and credit card debt).
- The new vehicles purchase plan.
- And many more…
SIDE NOTE: My main priorities in this category are to build up my emergency fund and pay down credit card debt. In my opinion, those are the two most significant areas that will prevent our ultimate goal of financial freedom!!!
So, let’s say your net income is $5,000 per month.
(1) 50% of that, $2,500 will go to essential expenses. These expenses will usually be fixed and non-negotiable. Your goal will be to limit this area to $2,500 or less every month.
SIDE NOTE: One grey area is minimum payments on credit card debt. These have to be paid until they are paid off and thus, can be considered essential. For myself, I will take into account all but one of my credit cards. The one I don’t account for will be getting more significant payments, and thus the minimums will be getting paid.
(2) 30% of your monthly income is $1,500. This money can be spent on gifts, dining out, fun activities, hobbies, etc. Your goal should be NOT ever going over this amount and even save some of this. Remember, any leftover “should” be allocated to emergency savings or debt repayment.
(3) Finally, 20% of your net income is $1,000. This money is the amount you should strive to utilize for savings and debt repayment. In this example, I would personally set aside $250 per month to an emergency fund, and the remaining $750 would go to debt.
SIDE NOTE: Make sure you have a figure in mind for your emergency fund. If you decide you will be comfortable with $2,000 then after that is saved, reallocate those monthly savings to debt repayment.
Self Employed or Work for Commission.
So, this can be a bit more difficult to budget because your income can be all over the place. My suggestion for this is to average your last 24 months of net income. Use that number as a baseline for your budget.
Advantages of This Method:
- This budget is easy for beginners.
- Calculating your different categories is very simple!
- This budget provides easily achievable spending limits.
- Can be applied at any income level.
Disadvantages of This Method:
- This budgets success can vary greatly depending on where you live. Cost of living plays a huge part in its effectiveness.
- It can cause high-income earners to overspend! High income bleeds over into higher spending limits in each category!
- Follow your budget, or you will not succeed in your primary goals.
- Make your budget as simple as possible. One way is to have broad expenditure categories, but not too broad!
- Be realistic! I cannot stress this enough!
- Focus on minor spending cuts at first, in a single category. Slowly build those spending cuts over a realistic amount of time.
- Review your budget OFTEN, and do NOT be afraid to make changes! Revise it as necessary!
- Make improvements as soon as you notice an area that needs it! Even the best plan needs improving! As time goes on you will likely discover several areas that need improvement.
- Focus on your emergency fund and paying off debt. Now, some people say pay off highest interest first. Others say the smallest balance. Which is right? Beats me, but I will say I am focusing on lower balances. This idea makes the most sense to me. Once the smaller balance is paid off, that frees up more extra money to pay off other things!
- Include your spouse! Make sure you are both on the same page!
- Always include money in your budget for entertainment! If you don’t, failure is more likely to occur. We ALL need to unwind.
- SIDE NOTE: In fact, the wife and I plan to catch a movie tomorrow!
I believe the 50/30/20 budgeting method can be a real game changer. However, as I said, I think the wants and savings categories need to be flipped, and when I finalize my budgeting plan, I intend on doing just that. One thing that I think makes this invaluable is because it is flexible enough to make changes as needed.
Your first steps, in my opinion, should be to figure out exactly where your money goes! For me, I am going to account for every single penny! However, the problem is, that is where the dull, unexciting parts are. Maybe you don’t need to go a full month like I am, but at least an entire pay period, in my opinion.
Once you have that part, find a good spreadsheet and start plugging in numbers! Don’t let this budget thing win! Let’s do this and become debt free!!!
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YOUR TURN – What budget method do you use? Let me know in the comments!! Please feel free to share on Facebook and Pinterest!