Creating a budget – and sticking to it – are fundamental elements of managing your personal finances.
There are many different budgeting methods you can employ, from the pay-yourself-first method where you set aside a specific amount each month to service debt and for savings to the highly disciplined “no” method where you simply avoid spending money you don’t have.
This article takes a closer look at the 50/30/20 budget, made popular by U.S. Senator Elizabeth Warren in her book, All Your Worth: The Ultimate Lifetime Money Plan.
5 Reasons Why Budgeting Is Important
Perhaps the main reason why it’s important to have a personal budget is that it leads to heightened financial accountability that in turn can lead to increased financial stability.
Budgets can help in numerous other ways as well, including:
- Fostering better fiscal stewardship and reduced anxiety regarding monetary issues
- Avoiding arguments over money for married couples
- Identifying important expenditures and areas of waste
- Helping you save more money
- Allows you to be ready for fiscal emergencies
For many, creating and adhering to a budget is the only way they can get ahead. Budgets can help people avoid the pressures of living paycheck-to-paycheck because they have put in the legwork to create a bit of financial padding.
Elements of the 50/30/20 Budget
The 50-30-20 budget is a popular way to budget because it's fairly simple. The budget calls for 50 percent allocation of monthly funds to needs, 30 percent for wants, and the final 20 percent for savings or to service debt.
Divvying up your money into these three buckets can provide structure to your spending habits and help you obtain important financial goals. Here’s a closer look at each:
- Needs. This category includes all your necessary expenses, such as food, rent, transportation, utilities, insurance, minimum debt payments, and other hard costs that can’t be avoided.
- Wants. This category is for the fun things in life. It includes dining out, new clothing, vacations, gym memberships, streaming subscriptions, and other luxury expenditures that bring enjoyment.
- Savings and debt. The final 20 percent of your net monthly income should be squirreled away as savings, placed into an investment or retirement account, or used as extra funds to pay down debt.
Putting this system into play requires you to determine your total after-tax monthly income, categorize your spending and place them into the appropriate bucket, and then adjust your spending to meet the 50/30/20 budgeting rule. As you define your spending habits, you may have to trim expenses in the wants category in order to more closely follow the 50-30-20 budgeting rule.
Problems with the 50/30/20 Budget Rule
This budget system may not work for everyone. The 50/30/20 budget rule doesn’t take into account personal monetary values, lifestyle choices, and individual financial goals. Inflation also makes this system untenable because it doesn’t account for escalating costs – more money will have to be funneled into the needs bucket to meet higher costs, and those funds will have to come from one of the other two buckets.
It also doesn’t take into account exorbitant cost-of-living expenses in cities like San Francisco, New York, Boston, or the Silicon Valley, where rents are far higher than in big cities with lower average rents, such as Houston, Indianapolis, Louisville or St. Louis. In the former, it’s unlikely that 50 percent of after-tax income will service rent, let alone all the other items housed in the needs bucket.
The Bottom Line
The 50-30-20 budget rule is a straightforward method to calculate expenses, luxuries, and put aside some money each month for savings. There are other methods that you can try as well if the 50/30/20 system doesn’t work for you. The main goal is to create a budget that allows you to make all your necessary payments, enjoy life a little, and put some money away for retirement or for emergency funds.
