(DailyChive.com) – There are numerous ways to create a budget. However, many of the available budgeting methods can be complex or leave gaps in your budget that make it difficult to maintain a consistent upward financial trajectory.
If you’re struggling to create or stick to your monthly budget, reverting to the basic 50-30-20 budgeting rule can help you handle your finances better. To date, it remains the simplest yet most comprehensive way to budget that addresses all important aspects of your financial life.
Here we’ll explain exactly how to use the 50-30-20 formula to design an effective budget where spending and savings are aligned. This way, you can achieve better financial health and reach your financial goals faster.
How the 50-30-20 Rule Works
The 50-30-20 or 50-20-30 rule is a simple budgeting strategy that helps manage money more effectively. The plan originated with current U.S. Senator Elizabeth Warren, and it recommends dividing your after-tax income into the main groups as follows:
50% on Essentials Needs
The rule recommends that half of your income should go to your most essential needs. Your must-haves could include monthly rent or mortgage payments, utility bills, groceries, transportation, and food.
Of course, essential needs can vary from person to person depending on their lifestyle. If your needs exceed the recommended 50%, make adjustments to lower the expenses, especially on items “you can live without.”
30% on Wants
After satisfying all your essential needs, 30% of your budget should go to the wants in your life. By definition, wants are non-essential expenses or things you choose to spend money on rather than need to spend money on. Examples of wants can include:
- Dining out
- Going to the movies or sporting events
- Vacations
- Internet or cable plan
- High-end electronic gadgets
- Gym membership
- Entertainment subscriptions (Netflix, Amazon)
Basically, wants are anything that can be considered optional. Also, your wants can vary because what you consider luxury may be a mandatory item in someone else’s life.
For example, if you work from home, a higher internet plan could be a must for your online work than someone working on the go. Because of this, financial experts consider wants a discretionary category in a budget but maintain that it should always remain below 30%.
20% on Savings
Lastly, your budget for your monthly after-tax paycheck should address the saving requirements in your life. In fact, some financial experts advise saving before satisfying wants, as saving can help you get ahead in your financial life faster.
The different types of savings accounts you should focus on growing are:
- Savings: You can save money in a current short-term saving account or long-term savings account such as high-yield accounts and certificates of deposit to invest and generate more wealth.
- Retirement: Although retirement might not seem scary when young, your sunset years can have many financial demands. You can make monthly contributions to an individual retirement account (IRA) or (401k) to secure your retirement years.
- Emergency fund: You can make monthly contributions to an emergency savings account for rainy days. This account should be separate from your regular savings account and have funds you can use for at least six months without any extra income.
- Debt repayment: Savings towards debt repayment should also be part of your 20% after-tax income. Regardless of how small the repayments are, consistently paying reduces the principal significantly and, thereof, interest.
Again, although important, all these are things that you should never go out of your way to satisfy. They should only come once the essential needs in your life have been sorted.
Don’t be a victim of circumstance. Take control of your financial life by creating an effective monthly budget for your essential needs (50%), wants (30%), and savings (20%). Remember, saving can come before wants, as they help you get ahead in life.
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