No matter what your financial status, you need to be cognizant of your money coming in and going out. A budget, or what I like to call a spending plan, is an optimal strategy to ensure the money going out is propelling you towards a better financial future.
The 50-20-30 Rule is a simplified process to budgeting. When we can simplify concepts, it is more likely we will stick to it, which is what can make this an effective way to spend more intentionally. Only 41% of Americans use budgets, likely because it feels complicated. Those that do utilize budgeting report that it helps them save and be financially prepared for the future.
A budget should operate off of your net income, meaning after taxes, social security, and medicare are taken out. If you are self-employed, this is your income after your estimated taxes are paid for the year. This gives us the baseline income to be used in our spending plan that will be separated out into 3 buckets of spending money.
Bucket One: 50% of Your Spending Plan
After you calculated your after-tax income, 50% of that income either on an annual basis or monthly basis, is to be spent on necessities. Half of that income is set aside in a bucket (or account) to be allocated directly to expenditures like groceries, rent, mortgage, utilities, healthcare, car payments and necessary insurance costs. These are usually fixed costs or costs with little fluctuation on a monthly basis and are unavoidable.
It’s important to focus on what we have control over. In this bucket, you want to really access what is, in fact, true necessities. For instance, is a car necessary, or would public transportation be a viable option. Similarly, expenditures like cable tv, Amazon prime, and other App subscriptions may not be necessary utility bills.
Bucket Two: 30% of Your Spending Plan
Your second bucket contains 30% of your after-tax income and is assigned to personal spending. The expenses in this bucket include shopping and entertainment activities, like groceries, dining out, Netflix, sports tickets, or drinks with friends. This category is for our mental health, but not all of these expenses have a lasting impact for our financial and physical wellness.
An important step to this bucket is to run through all of your personal spending from the 60 days prior to this budget. Next to each expenditure in this personal spending category, rank the level of fulfillment you received from that expenditure on a scale of 1-10. Once you have done that, go back through and consider getting rid of the expenses that were ranked 6 and below. This should help limit this bucket to 30% of after-tax income.
Bucket Three: 20% of Your Spending Plan
This bucket is about increasing your financial stability and long-term net worth. With the remaining allocation of your after-tax money, use these funds to pay down debts. This debt might be car payments, credit card debts, mortgage and any other owed money. Note that this category is for paying beyond the minimum payments, as minimum payments would constitute a 50% bucket allocation to necessities. Once those debts have been paid off, those allocated funds can start to go towards additional savings beyond your emergency fund.
This is the most important bucket, as it immediately begins to increase your financial picture for now and in the future. Both a reduction in liabilities and an increase in savings begins to add to your bottom line, helping position you for more freedoms now and in retirement. Thinking about your future self and connecting with that person is vital to this part of the budget.
Putting It All together
The next paycheck that you receive, break your after-tax and benefits net income into three percentages. The figures you come up with are the absolute maximum you can spend in each bucket. If you are finding that you spend too much in any particular bucket, you must find ways to trim expenses.
The word budget is difficult for human psychology because your brain looks at it as deprivation. However, if you stick to the 50-20-30 spending plan, the long-term psychological benefits will far outweigh any immediate discomfort.
Important Disclosures:
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
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