Yahoo Finance What is the 50/30/20 budget rule and why should you follow it?
When it comes to managing and budgeting your money, there are a lot of methods to choose from that can make the process work for you.
And while some methods require spreadsheets or the help of a financial planner, one rule, popularised by Senator Elizabeth Warren in her book All Your Worth: The Ultimate Lifetime Money Plan, makes budgeting simple.
The tactic, referred to as the 50/30/20 rule, teaches people how to allocate their money towards paying their various expenses in an efficient way - by breaking spending into categories.
This is what you need to know about budgeting using the 50/30/20 rule and why people still rely on the technique to this day.
What is the 50/30/20 rule?
The 50/30/20 rule is a simple plan that categorises spending into three categories: needs, wants and savings.
The first category, the 50 per cent category that comprises half of your income, is the money you make in after-tax income that must go towards paying bills such as rent or mortgage payments, insurance, utilities, minimum debt payments, car payments, groceries, transportation to work and health care.
This category is the most important, as it is the bills that you must pay each month. While this category requires half of your income, these bills should not exceed the 50 per cent mark.
The second category, which should make up 30 per cent of your after-tax income, is the wants category.
This category is for all of the things that you spend money on that are not essential, such as coffee, dining out, vacations, tickets for movies or concerts and shopping.
The wants category, which is anything that is considered optional spending, also includes TV and gym subscriptions, and nonessential upgrades to cars or tech gadgets.
The third category, made up of 20 per cent of your income, is the money that should be allocated towards savings, or money put away as part of an emergency fund, as well as investments or debt-reduction payments.
How do you begin following a 50/30/20 budget?
The first step in incorporating the budgeting rule is determining how much money you make each month.
After establishing how much you make after tax, you need to track your spending to see where your money is going.
Once you’ve tracked your monthly spending, you will be able to identify how much you are allocated to each of the three categories - and adjust accordingly if needed.
For example, if you find that you are having difficulty affording rent each month, it may indicate that you need to cut back in the wants category, possibly by cancelling a gym membership or streaming subscription.
If you still cannot afford your needs category after allocating 50 per cent of your income, it may mean making bigger changes, such as finding a new apartment or house that fits better into your budget.
For the budget to work, you need to stick with it, which can be easier to do if you separate your money as soon as you earn it.
Why should you follow the 50/30/20 rule?
Prior to running for president, Ms Warren worked as a bankruptcy and personal finance lawyer, before becoming a law professor at Harvard University.
In 2003, the Democratic senator and her daughter Amelia Warren Tyagi, a financial consultant, co-wrote The Two-Income Trap, which became a bestseller.
After the success of the first book, the pair co-wrote All Your Worth in 2006, which outlines steps for budgeting based on the 50/30/20 rule.
Some of the lessons in the book include the importance of focusing on the bigger picture rather than small changes, as well as the necessity of paying off what Ms Warren calls “steal-from-tomorrow debt” such as credit card debt or medical bills.
“Here’s a little secret that the other financial books won’t tell you: Savvy money managers don’t spend a lot of time looking for ways to save a few pennies,” they wrote. “They charge right ahead to the big-ticket items, looking to make high-impact changes in the shortest period of time. They don’t sweat the small stuff. And neither will we.”
The book also emphasises the idea that debt is not completely the fault of the consumer, and that some blame should fall on banking systems and the finance industry.
“In today’s world, you can get a mortgage that is too big for you—and the banks will help you do it. You can get a car lease that chews up half your income. You can wind up with a student loan bigger than some home mortgages. And as sure as the sky is blue, you can rack up credit card debt without blinking an eye, even if you don’t have 50 cents to make the payments,” they wrote.
In addition to Ms Warren and her daughter’s expertise on the subject, they acknowledge in the book that the budget is not a quick-fix, but rather a method for building wealth over a period of time.
While there is some debate over whether Ms Warren is the inventor of the rule, the popularity and recognition of the 50/30/20 rule is widely attributed to the presidential hopeful.
