There are many different strategies for approaching building a budget. In fact, there are a number of budgeting apps and programs available that can do much of the work for you. Understanding how to build a budget on your own, though, can have major benefits for your long-term financial health.
The 50/30/20 budget, first mentioned in Elizabeth Warren and Amelia Warren Tyagi's 2005 book "All Your Worth: The Ultimate Lifetime Money Plan," is one way you can go about doing things.
What Is the 50/30/20 Budget Rule?
The 50/30/20 budget breaks your money up into three basic divisions: needs, wants and debt/savings. Parceling up your costs in this way can help you understand where your money is going more precisely.
You'll start by calculating your monthly take-home pay. This is your salary minus taxes. If you have a health insurance plan or retirement contributions deducted from your paycheck, add those back in. Now you know your monthly pay, let's divvy it up according to the budget.
It's important to note that the 50/30/20 budget assumes you bring home roughly the same amount of money each month. If your income is less stable from month to month, you may want to find a budgeting method that works better for your situation.
50% of Your Budget for Needs
Divide your monthly pay in half. That number is the amount of money you'll allocate for needs. Housing, utilities, health insurance, groceries, transportation and prescriptions all count as needs. Some debt is considered a need as well, such as credit card payments or car payments. If you miss payments, your credit score is negatively impacted. Other needs include child support and alimony. Missing payments for either will get you in hot water. Therefore, it's a need.
But that's not an exhaustive list. If you're not sure what's a need versus a want, consider the impact if you take it away. Health insurance, for example, is a need because you'll incur fines if you forgo coverage. Plus, it's essential for your wellness. Trickier situations, such as whether your cell phone is a need or a want, take more thought. It might be a need, but owning anything above a base model cell phone and basic phone plan tilts more toward a want.
"People don't realize that many of their needs are really classified as wants (such as cable and morning lattes) and they may blow this ratio quickly," Andrea Woroch, a consumer and money-saving expert, told SmartAsset. She suggests starting "by making an honest assessment of your spending and look for ways to improve and cut back."
30% of Your Budget for Wants
Now for the fun stuff: wants. Multiply your monthly take-home pay by 0.3 to find the amount you have in this category. A want is anything that's not a basic need to survive. Vacations, cable and Netflix, gym memberships and dining out all count as "wants." Salon visits and clothes shopping are part of the category, as well. Where the line gets fuzzy is with expenses you may consider essential, but in reality, could live without. This could mean high-speed internet in your apartment or leasing a large car instead of economy-sized.
With the 50/30/20 budget, you allocate a larger percentage of your money for wants versus savings. You may want to change your allocations if your goal is to build wealth or pay down debt as fast as possible.
20% of Your Budget for Debt/Savings
To find what you should set aside for debt and savings, multiply your take-home pay by 0.2. For example, if your paycheck after taxes is $3,200 a month, you'd put aside $640 for debt and savings ($3,200 x 0.2). Savings include retirement accounts, emergency funds and whatever other financial goals you have. Woroch even recommends you "put [your] savings away first before paying for other luxuries." A savings calculator can help you see how this money will grow over time.
As for debt, this category includes student loans or other debt you want to put extra money toward paying off. While the "needs" category may have included a large portion of your essential must-pay debt (such as your credit card), this money is for any extra payments you can make once you put aside retirement or health savings account funds.
Bottom Line
You don't have to feel tied to the 50/30/20 rule. If you want to tweak it to your personal financial goals, you can absolutely do so. While you probably don't want to dip below saving 50% for needs, you can always scale back wants and add more to your savings. On the flip side, if you're debt-free and have healthy savings, perhaps you can allow yourself more wants. Or, perhaps you add a percentage for charitable contributions. Whatever your financial goals are, remember that making a plan is the best way to meet them.
Finally, Woroch cautions against jumping into the plan too quickly. While saving 20% may not seem like a lot, you might surprise yourself. "Take it step by step though because it's a lot easier to adjust to small changes than to a complete life overhaul."
This story originally appeared on SmartAsset and has been independently reviewed to meet journalistic standards. For more information, contact [email protected].
