Think of this – you’ve just been paid and have some money left over. You’ve always been told to put some of it into your savings account or investments, but how much? Too much into your savings, and you’ll be living off rice for the rest of the month. Too little, and you might find yourself working until you’re 90 as you don’t have enough to retire with. I’ll break down the 50/30/20 rule of budgeting to see why it’s so effective. We’ve also created a free template to help you get going.
What is the 50/30/20 Rule?
It all started with Elizabeth Warren, a Harvard bankruptcy expert and one of Time magazine’s 100 Most Influential People in the World. She came up with the term when helping to save money with her daughter, Amelia Warren Tyagi. Below is her breakdown of how it works.
As shown above, this technique categorises your monthly expenses into three main sections: “needs”, “wants” and “savings”. These will all be explained below, as well as the steps required to use this budgeting rule.
Step 1: Calculate your income after tax
If your employer hasn’t done this already, it’s what remains of your income once all the taxes have been taken out. This includes your income tax, medical aid, and other contributions as well.
Step 2: Allocate 50% of your income after tax to needs
Once you’ve calculated your income without tax, try and dedicate half it to your “needs”. These can include:
- Utilities (lights and water)
- Car insurance
- Car repayments
- Health insurance
- Rent or a housing mortgage
- Home security
There might be a few others, but essentially these are expenses you have to pay each month no matter what. In some cases, it might be over 50%, such as paying for your two people if you’re in a relationship.
The easiest way to know the difference between “wants” and “needs” is that needs play a big role in your quality of life if left unpaid (think food or health insurance).
When looking at paying back retail clothing accounts or your credit card account. It may seem like these aren’t negatively impacting your life, but bad credit scores do. In the end, your needs are paid with fewer emotions. You have to pay them or else your next month will be a lot tougher, plain and simple.
Step 3: Allocate 20% of your income after tax to savings and debt repayments
Quite often, your savings are left until last. However, I enjoy calculating them straight after my needs. This allows for much stricter control to be applied to them. You might struggle with thinking some “wants” are more important and fall into a need category. Some examples of savings are:
- Repaying debts
- An emergency fund
- Retirement annuities
If you have a bond or a vehicle loan, this would be considered a “need” and any extra payments will then fall into this section. Same applies for credit or retail cards as mentioned in Step 2.
Step 4: Give the rest to your wants
This now leaves you with around 30% to spend on whatever you want. I don’t mean taking it to the casino or putting it into Bitcoin. You still need to factor in other important payments such as gym contract or Netflix. You may consider these as “needs” however, you can still function normally without these for a while. Your internet would also be considered a want unless it’s for business purposes.
It’s not always easy knowing exactly how much money goes into each category. Using apps like 22seven or even just a spreadsheet can really help. If find too much is going into your “wants” and not enough into your savings, think about changing your spending habits. Perhaps saving first before spending it all at once will be a good change to your monthly routine.
- Always keep reviewing your “wants” and “needs” – what may be a “need” in one month could turn into a “want” in another month.
- Reduce your “needs” as much as possible – by finding out if discounts are available (not by not paying them)
- Don’t go crazy on the “wants” – reduce your “wants” too by finding cheaper alternatives or discounts, it allows more savings to be done
- Using an 80/20 rule instead – if you struggle to determine what’s a “need” and what’s a “want” every month, allocate 20% to savings and the rest is expenses. In other words, you don’t have to do any expense tracking as your savings are sorted the rest goes to everything else
The 50/30/20 rule is a very popular way of sticking to a suitable budget. Your “needs” remain the priority while your savings and debt repayments are still looked after. It also forces you to you have “wants” money to get more enjoyment out of the budget. If you struggle to stick to a budget I’d recommend either the 50/30/20 rule or the 80/20 rule. Both help in certain situations. We’ve also developed a free template to setup your 50/30/20 budget below. Give it a try and let us know what you think!
Images via unsplash.com