As I share in the FinancialVerse – A Common Sense Approach for Your Money, there are 10 Must Do’s to manage your financial life. One of those is to have a budget. If you can’t measure your net cash position each month, you can’t manage it.
There are a number of ways to create and manage a budget. One of the methods that is getting a lot of positive press is the 50/30/20 approach. This method was made popular by Senator Elizabeth Warren ( I am not expressing any political opinions) in her book, All Your Worth: The Ultimate Lifetime Money Plan. The method’s basic rule is to divide your after-tax income (after all income tax withholdings) and spending 50% on basic needs, 30% on wants, while allocating 20% to building your savings and repaying debt.
Here is an overview of how the approach works:
Your After-tax Income
Your after-tax income is the pay you take home after federal, state and local taxes. However, to get an accurate starting point, look at your paystub; if you have automatic deductions for things such as health insurance and retirement savings, add those items back in to calculate your after-tax income. This will give you the amount of cash income you are generating before any basic living expenses and savings are taken out.
Your Basic Needs – 50%
Your basic needs can be defined as those bills that you absolutely must pay and are mandatory living expenses. These include rent or mortgage payments, real estate taxes, car payments, groceries, insurance coverage, health care costs, minimum required debt service payments and utilities. The "basic needs" category does not include items that are extras, such as Amazon Prime, NFL Sunday ticket, tickets to sporting events, drinks at Starbucks and costs of dining out. Fundamentally this is the cash needed to pay your bills and live day-to-day without any frills.
Your Wants – 30%
Wants are all the things you spend money on that are not absolutely needed or essential. This includes dinner and movies out, the expensive mountain bike, tickets to sporting events, vacations, the latest electronics gear and ultra-high-speed internet. This category also includes those upgrade decisions you make, such as choosing a costlier steak instead of a less expensive hamburger, buying a BMW instead of a more economical Subaru or choosing between watching television using an antenna for free versus spending money to watch cable TV. Basically, wants are all those little extras you spend money on that make life more enjoyable and entertaining. I am not going to tell you to avoid spending money on these extras, but instead you must understand what you are spending and make good decisions about the total amount spent.
Savings for Emergencies and the Future – 20%
The method dictates that you allocate 20% of your income to extra debt repayment, savings and investments. This includes adding money to an emergency fund in a bank savings account, making 401(k) and IRA contributions and making stock market investments.
Savings can also include debt extra repayments. While minimum debt service payments are part of the "needs" category, any extra payments reduce principle and future interest owed, so they are savings.
Summary
Having a budget is mandatory in the FinancialVerse. How you create and maintain that budget is up to you. What works for one person may be a huge distraction for another. The 50/30/20 method provides some people with a framework to approach the task of creating and maintaining a budget. As we know, under 30% of people have a budget and follow it.
This method is relatively simple to follow and helps create the good financial habits of budgeting, awareness of where your money goes and ways to save for emergencies and the future.
Establishing good financial habits pay lifelong dividends and the 50/20/20 method may help you successfully develop these habits.