Have you decided to bite the bullet and make out your first budget? Or have you been trying to budget unsuccessfully for a while now?
Either way, you need a budget formula that works for you.
Some people hear the word budget and immediately feel stressed out. But you shouldn’t!
Budgets aren’t a ball and chain. They’re not going to limit your freedom. It’s quite the opposite, in fact – budgets give you more freedom than you’ve ever had before.
They can give you freedom from worrying you’re going to overspend each month.
Budgets aren’t a constraint – they’re a useful tool that puts you in the driver’s seat. They help you make better decisions.
A good benchmark to shoot for when constructing your budget is to follow the popular 50-30-20 rule (also known as the 50/20/30). It’s a balanced budget you should be able to stick to. It will help you stay on point without being so restrictive you can’t enjoy any extras.
Let’s look at the 50-20-30 budget formula and how it works.
What’s Included in the 50?
This rule states you should put 50 percent of the money you bring in toward necessary items, such as housing, transportation, and other bills.
Here are some of the things included in this category:
- Rent or mortgage
- Transportation, including car payments and gas
- Groceries, but not eating out in restaurants
- Basic clothing
The items in this category are what you’ll need to survive in this world – shelter, clothing, transportation, food, and being adequately insured.
The trick for some people is keeping this number down to 50 percent. If you don’t make smart decisions about what you can afford when you buy a house, for instance, that number can spiral out of control quickly.
For example, one mistake I see is people confusing the amount a bank will approve them for a loan vs. the amount they can actually afford. When a bank says you’re approved for a loan for say $300,000 that’s what the banks have determined is the largest amount of debt you can take on with a reasonable chance of paying it back. This maximizes the bank’s bottom line, not your finances.
What’s nice about the 50/30/20 budget formula is it has your best interests in mind–not the banks!
Related Reading from The Ways to Wealth
- 6 Personal Finance Ratios You Need to Know
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- 27 Creative & Smart Ways To Pay Down Debt on a Low Income
What’s Included in the 20?
The next number to think about in this budget formula is 20 percent. While the last number focused on your necessities for the present, this number is all about the future. This is how you’re going to gain financial traction.
This money will go to your financial goals. That can mean your emergency fund, investments, and payments you make toward debt reduction. If you have credit card payments, these are included here. You should also include any extra money you can put toward your car payment and mortgage.
This category is invaluable because as you pay off your existing debt it will drop your necessities percentage even lower, which will free up more money for your wants and investments.
Don’t have financial goals? Download The Ways to Wealth’s Free Financial Goal Setting Workbook below:
What’s Included in the 30?
This is what some people will think of as the fun category! This category includes the things you want but could certainly live without. Travel, concerts, and nights out with friends all fall into this category.
While basic clothing needs can be covered in your 50 percent category, this is where you’ll put the unnecessary and expensive clothing you could certainly do without (but since you’re on a budget, you get to actually have).
Or better yet — you can use this money to double down on one of your most important financial goals, such as getting out of debt, i.e… buying your freedom.
Want to go on a dream vacation? This is where you’ll come up with the funds for that. By careful planning, you’ll cut back on the other extras in this category to make that happen.
That’s the fun part about this budget. You get to decide exactly what to do with your 30 percent. It can feel liberating instead of confining.
How to Get Started with The 50/30/20 Budget Formula
Getting started will take a little legwork, but it will pay off big time in the future as long as you stick to your budget formula. Here’s what you’ll need to do.
Step # 1 – Look At How Much Money You Bring Home.
What you’re looking for is how much money you earn in a month after all your taxes and other deductions are taken out. That is what you’re going to have to work with.
If you have a side job, you should include that bring-home amount too. The idea is to get a handle on your complete financial picture.
If you’re a freelancer or self-employed, your budget will likely fluctuate from month to month. Figure your average monthly income and go from there.
Step # 2 – Track Your Spending
Pay attention to every cent you spend and track where it’s going. Figure out which category it belongs to. This is made a lot easier when you’re using a personal finance tracking app–my favorite is Personal Capital (Click here to sign up for Personal Capital and get a free $20 Amazon gift card) but Mint is another one to try.
You may notice after watching your spending for a month that your numbers are completely out of whack. You might see you spend way more than 50 percent on essentials or that you blow half your budget on wants.
Step # 3 – Start Tinkering
After you’ve seen what your month’s figures look like, it’s time to start revising your spending to fall within the 50-20-30 budget formula. That might take some creativity on your part.
If your necessities are taking up way more than 50 percent of your income, you’ll need to reevaluate what you consider necessities and how much you spend on them.
This is also where you’re going to take advantage of some straightforward ways to saving money.
And while saving money is a start, you can just as well make more money.
If you find despite your best efforts you can’t get under 60 percent for your essentials, don’t feel like you can’t use this budget formula. The best part about it is how flexible it is.
Maybe for the time being your budget formula will look like 60-15-25. That’s perfectly okay! You’ll still make progress and that’s all the matters! Just keep working to eventually make your way to 50-20-30.
Why It Works
With this budget, you’ll make progress toward your financial goals without feeling deprived. Instead of feeling stressed when you look at the upcoming month’s budget, you’ll feel excited.
You’ll be paying for your essentials while protecting your future and having fun too!
Related Reading from The Ways to Wealth
- The Ultimate Guide To The Cash Envelope System
- The Dave Ramsey Allocated Spending Plan: Guide + Worksheets
- Top Cash Back Apps For Groceries: Apps That Pay You For Your Receipts