Budgeting is a great way to track where your money goes each month and an important step to getting your finances in order.
It empowers you to reach important milestones like building an emergency fund or saving for a home down payment.
While budgeting may seem daunting initially, it doesn’t have to be complex or time-consuming. And if you’ve felt disappointed with budgeting apps, there’s no need to worry.
In fact, I’ve uncovered a simple yet effective solution: the 50/30/20 rule. This rule divides your income into necessities, wants, and savings, offering a clear path to financial management.
Here’s how it works!
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What is the 50/30/20 Rule?
The 50/30/20 rule is a straightforward budgeting method that empowers you to manage your finances effectively, simply, and sustainably.
Here’s how it works:
You divide your monthly after-tax income into three main spending categories. You allocate 50% for needs, such as rent, groceries, and utilities, 30% for wants, like dining out, entertainment, and shopping, and finally, 20% for savings or paying off debt.
When you consistently balance your expenses across these categories, you optimize your money management.
With only three major areas to monitor, you save time and alleviate the stress of scrutinizing every expense.
However, remember that the 50/30/20 rule serves as a guideline for budget planning. The exact percentages may vary based on your individual financial circumstances, including factors like your local cost of living and inflation rate.
One common question people ask about budgeting is, “Why can’t I save more?” The 50/30/20 rule addresses this dilemma by providing a structured approach to your spending habits.
It facilitates progress towards your financial objectives, whether you’re building an emergency fund or tackling debt repayment.
Where Did the 50/30/20 Rule Come From?
The 50/30/20 rule originated from the 2005 book, “All Your Worth: The Ultimate Lifetime Money Plan,” authored by current US Senator Elizabeth Warren and her daughter, Amelia Warren Tyagi.
Drawing from over 20 years of research, Warren and Tyagi advocate for a simple yet effective approach to financial management.
They assert that you don’t need a convoluted budget to gain control over your finances.
Instead, they propose balancing your money across your needs, wants, and savings goals using the 50/30/20 rule.
How to Budget Your Income With the 50/30/20 Rule
Budgeting your money with the 50/30/20 rule simplifies the process by breaking down your after-tax income into three distinct spending categories:
- Needs
- Wants
- Savings or debts.
Understanding the precise allocation for each category makes it simpler to adhere to your budget and maintain control over your spending habits.
Here’s a breakdown of what a budget following the 50/30/20 rule entails:
Spend 50% of your Income on Needs
Needs are expenses that you can’t avoid—payments for all the essentials that would be difficult to live without. Your most necessary costs should be covered by half of your after-tax income.
Needs may include:
- Monthly rent
- Electricity and gas bills
- Transportation
- Insurances (for healthcare, car)
- Minimum loan repayments
- Basic groceries
For example, if your monthly after-tax income is Ksh.100,000, Ksh. 50,000 should be allocated to your needs.
Keep in mind that this budget may vary from person to person. If your needs add up to much more than 50% of your take-home income, you may be able to make some changes to bring those expenses down a bit.
This could involve simple adjustments like switching to a different energy provider or finding new ways to save money while grocery shopping.
It could also entail more significant life changes, such as seeking out a less expensive living situation.
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Spend 30% of Your Money on Wants
Allocate 30% of your after-tax income to cover your wants, with 50% already dedicated to your basic needs.
Wants are expenses considered non-essential—things you choose to spend your money on, although you could live without them if necessary.
These may include:
- Dining out
- Clothes shopping
- Holidays
- Gym membership
- Entertainment subscriptions (Netflix)
- Groceries (other than the essentials)
Using the same example as above, if your monthly after-tax income is KSH. 100,000, you can spend Ksh. 30,000 on your wants. If you find yourself spending excessively on wants, consider which expenses you could reduce.
Following the 50/30/20 rule doesn’t mean sacrificing enjoyment in your life. It means being more mindful of your spending by identifying areas where you may be overspending unnecessarily.
If you’re unsure whether something is a need or a want, simply ask yourself, “Could I live without this?” If the answer is yes, it’s likely a want.
Save 20% of Your Income
With 50% of your monthly income allocated to your needs and 30% designated for your wants, the remaining 20% can be directed toward achieving your savings goals or paying back any outstanding debts.
While minimum repayments are considered needs, any extra repayments reduce your existing debt and future interest, hence classified as savings.
Consistently setting aside 20% of your pay each month can significantly contribute to building a robust savings plan.
Whether you aim to establish an emergency fund, devise a long-term financial strategy, or prepare for a down payment on a house, this allocation proves beneficial.
It’s remarkable how swiftly savings can accumulate. For instance, if you bring home Ksh. 100,000 after tax each month, allocating Ksh. 20,000 toward your savings goals means you could save close to KSH. 240,000 in just a year.
How to Budget With the 50/30/20 Rule: A Quick Guide
In this section, I’ll provide a step-by-step guide on budgeting using the 50/30/20.
Let’s get started.
1. Calculate your After-Tax Income
Begin by determining your after-tax income, which is crucial for applying the 50/30/20 budgeting rule.
If you’re a freelancer, this entails deducting your business expenses and tax reserves from your monthly earnings.
For employees with a steady paycheck, it’s simpler. Review your payslip to identify the amount deposited into your bank account each month.
If deductions like health insurance or pension funds are automatically withheld, ensure to include them back in your calculation.
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2. Categorize your Spending for the Past Month
To gain insight into your monthly expenditure, review your transactions over the past 30 days.
Obtain a copy of your bank statement, which typically categorizes transactions into sections like Salary, Food & Groceries, and Leisure & Entertainment.
Divide your expenses into three categories: needs, wants, and savings. Needs encompass essential expenses like rent, while wants include discretionary spending such as dining out.
Savings involve additional debt repayments, retirement contributions, or funds set aside for emergencies.
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3. Evaluate and Adjust your Spending to Match the 50/30/20 Rule
With a clear understanding of your spending breakdown, assess how much of your income is allocated to needs, wants, and savings each month.
Align your budget with the 50/30/20 rule by focusing on your wants. According to this rule, wants are not extravagant; they are basic pleasures that enhance your quality of life.
Rather than trimming essential expenses, identify discretionary spending areas where reductions can be made to adhere to the 30% limit.
By reducing spending on wants, you increase the likelihood of achieving the 20% savings target.
50/30/20 Rule Spreadsheet
While a 50/30/20 rule calculator offers a broad overview, a spreadsheet provides a more detailed budgeting tool.
Utilize spreadsheet software like:
They offer ready-made templates tailored for budgeting purposes. Numerous free online 50/30/20 rule spreadsheets are available, compatible with various software platforms, facilitating comprehensive budget management.
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Final Thoughts
Budgeting methods can help you feel more reassured and in control of your financial picture.
Also, it allows for better planning and allocation of resources, fostering a sense of financial stability.
And if you use the 50/30/20 rule, you’ll find a simple yet effective way to manage your money, ensuring that your needs, wants, and savings are all accounted for.
So, start implementing this rule today and see your finances flourish with purpose and efficiency.
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