Most people find budgeting to be boring and unexciting. Especially if they’re plenty of bills outstanding than available resources. Of course, it’s a pretty discouraging and upsetting situation. However, the scenario seriously calls for a basic understanding of how to budget.
Operating without a budget is the fastest path to going broke. Because it’s difficult to channel expenditures towards items that help meet your long-term and short-term financial goals.
WHAT IS A BUDGET
In a nutshell, a budget allocates personal income towards expenses, savings, and debt repayment. For this reason, it leaves emotions out of the household expenditure process. In addition, it guides and controls individuals or household spending.
For the most part, budget tracks and projects your monthly expenses. As a result, it accounts for cash inflows and outflows from a centralised primary expenditure account.
WHAT IS THE 50/30/20 BUDGETING METHOD
It is a budgeting method that divides your net income into three categories: your essential needs, wants, savings and debt repayment.
HOW TO BUDGET WITH 50/30/20 METHOD
To establish the 50/30/20 budget first determine your three essential categories: needs, wants, and savings. Then calculate your actual net income to spend 50% on needs, 20% on savings and 30% on wants.
STEP 1 – Establish the take-home pay or after-tax income
Your take-home pay is the net income that hits your bank account after the following deductions from your gross income:
- Federal/provincial taxes
- Unemployment insurance
- Health and dental insurance
- Pension contributions
Once you’ve calculated your net income, then it becomes a basis for the 50/30/20 budget.
STEP 2 – Calculate 50% of your net income and allocate it to essential expenses (these are necessary expenditures that you can’t live without to survive).
- Mortgage and homeowners insurance – Rent and possessions insurance (if you rent)
- Utilities – water, natural gas (in Canada can’t live without) and electricity
- Food – groceries, (exclude dining expense because it’s in the 20% category)
- Transportation – gasoline or bus/train pass if you ride the bus/train to work
- Contractual obligations – such as internet and cell phone bills have become the new “necessities.”
STEP 3 – Calculate 30%-Discretionary Personal Expenses or Wants. Wants are the following expenses:
- Vacation and dining out
- Gifts (Christmas gifts, birthday gifts and wedding gifts)
- Cable TV
- Hobbies (gym membership or magazine/online subscriptions)
In so many ways, the 50/30/20 budget will assist you to establish the right way to spend your money. If carefully adhered to it cuts unnecessary overspending, increase savings and speed up debt elimination. To achieve impressive goals with the 50/30/20 budgeting method. You need to be intentional in regards to where you spend your money and always stick to your budget.
STEP 4 – Calculate 20% for Financial Priorities
Without a doubt, this is a critical category in your budget. It’s where you set your Financial Goals. Your target should be to put away 20% of your net income into:
- Savings for an emergency. Emergencies are inevitable, and you can’t ignore them
- Retirement savings
- Down payment for a house fund
- Debt repayment (student loans and credit card debt)
- The new vehicles purchase plan
- College/University fund for yourself or children’s education plans
- Dream vacation (if you plan to take a trip around the world or to Tahiti)
- Wedding fund (weddings can be very expensive, and early planning is critical)
THE 50/30/20 BUDGETING EXAMPLE
Admittedly, start by looking at your net income, let’s assume you earn $3000 every month. The 50/30/20 budget keeps it relatively easy to follow and calculate. For one thing, the 50/30/20 budget is forward-looking and flexible as you go. In total contrast to a traditional budget where you budget based on historical expenditures.
As an illustration here is how you will determine the 50/30/20 budget equation each month.
(1) 50% of your net income is allocated to ESSENTIAL expenses
Normally, these expenses are inflexible and non-negotiable every month. Your take-home pay is divided by two each month to establish the 50% required to spend on ESSENTIALS.
In this example, your net income is $3000 therefore 50% is $1500. Your aim should be to limit essential expenditures to $1500 monthly. For instance rent or mortgage, utilities, groceries, and transportation within the allocated amount.
Note: Every month your objective is to limit your expenditures for the essentials within $1500.
If there are excess funds in the 50% category of your net income. It should be channeled towards debt elimination, increasing emergency savings and retirement fund. If you’re coming up short in this category, you might cut on wants to boost needs in the short term.
In particular, consideration of the grey areas is critical for the budget’s effectiveness. For instance, the minimum payments to a credit card, vehicle loan, and student loan should be calculated as a need. You can’t disregard them as they’re a fixed cost outlay until they’re paid off.
(2) 30% of your net income – Allocated to Personal Expenses
In this example net income is $3000 x 30% = $900. This amount is spent on fun activities like dining out, entertaining friends and family. Use the budget allocation to purchase clothes for yourself and gifts for loved ones. You can also spend it on hobbies and anything else you can imagine.
If your monthly expenditures on priorities are less than 30% of your net income. Assign the excess funds saved towards savings. Never budget more than 30% in this category to keep the accounts to balance.
(3) 20% of your net income – Allocated to Financial Priorities
Finally, 20% of your net income in this example is $600.Spend it on savings, boosting an emergency fund, repaying debts and investments (excluding retirement savings). You can fit in more debt servicing over and above the minimum if you want to pay it off fast.
Income for retirement does not count towards the 20% savings. This category is strictly for saving for emergencies, vacations, and other investments.
Here’s the breakdown
- Rainy day fund (for emergencies)
- Vacation (winter break to the Bahamas)
- Extra payment towards student loans
If you have any leftover cash from this category, dedicate it towards debt repayment
HOW TO USE 50/30/20 BUDGET IF YOU’RE SELF EMPLOYED
For those paid on commission or self-employed, obviously, your income is all over the place. Use the average of the past twenty-four months to determine your monthly income.
To arrive at your net income use gross income earned minus business expenses. For example, Gross income MINUS income taxes, as well as pensions contributions = Net income.
Use net income as a starting amount for creating a budget
ADVANTAGES OF 50/30/20 BUDGET RULE
- Easy to adapt for beginners because the baseline is 50% of your income.
- It’s quick and straightforward to calculate the size of 50/30/20 buckets )
- Provides well-balanced limits/parameters
- Applies to everyone in any income levels)
DISADVANTGES OF 50/30/20 BUDGET RULE
- All in all its a very interesting budgeting concept. However, regrettably, it depends on what part of the country you reside in. Some cities rent is very expensive, so it surely takes up most of your net pay chunk.
- Those who reside in expensive cities with a high cost of living. Particularly find it difficult to allocate 30% towards discretionary spending.
- It leads to high-income earners to splurge more on stuff they don’t really need. Because high income translates into a high ratio on all categories.
This budgeting method is excellent for someone who’s just starting out and learning how to budget. In addition, it needs assistance to determine how to spend or set aside money for each category.
You can establish an ambitious budget on paper or in an Excel spreadsheet. However, if you don’t correctly follow it, forget about reaching the intended objectives. Be cautious of elements that can destroy your budget.
Here are the budgeting tips to help you establish a realistic and successful budget that achieves intended results:
PRIMARY BUDGETING TIPS
- Keep it simple and extremely short. For easier tracking of expenditure items, always include a large block of general categories in the budget. Avoid making it too complicated to manage.
- Be realistic. Otherwise, it becomes a self-destructing scheme. Your budget should match your monthly income, anticipated expenditures and amount set aside for savings.
- Avoid wholesale cuts. Focus on one budget item to initiate cuts and do it gradually over a realistic period.
- Start with the essential categories first. For instance savings, monthly bills, and lastly entertainment.
- Revise and review your monthly budget at least once every month. Do not shy away from adjusting provisions to specific areas in the budget. Make it a point for your budget to match cash inflow realistically. Always be watchful for areas that need improvements or cuts and change accordingly
SECONDARY BUDGETING TIPS
- Focus on paying off debt if you have some. Start with paying off the smallest debt first and work your way up to more significant obligations to wipe off the payment.
- If you’re married, do the budget together with your spouse. Because you’re on the same page regarding spending and saving expectations. Above all, it will reduce the risk of sabotage.
- Always budget for entertainment. Avoid cutting essentials entirely out of your budget and allow yourself to indulge in controlled shopping therapy or entertainment. If it’s budgeted for, don’t beat yourself up for it. We all need it at one time or another. Otherwise, you risk sabotaging the whole plan.
This budgeting method is brilliant for someone just starting out and needs help channeling funds to each category.
RE-EVALUATE THE BUDGET AND MAKE PROPER ADJUSTMENTS
Even the best-laid plans encounter issues that call for adjustment. In a similar fashion, re-evaluating a budget periodically allows you to realise if there were spending issues that need adjustments. It identifies an area within the budget that was out of line with your priorities. As a result, make corrective action as needs and wants can change over time.
THE 50/30/20 BUDGETING METHOD ISNT FOR EVERYONE
All things considered, the 50/30/20 budget concept is a brilliant foundation for effective budgeting, despite the fact that it doesn’t apply to everyone. If you feel that this budgeting method isn’t right for you, I suggest trying other budgeting techniques.
Let circumstances determine the budgeting method that you pick. Carefully, review other budgeting methods out there like zero-based budgeting, envelope budgeting system, and many others. Don’t shy away from experimenting until you find a perfect method that precisely works for you.
Once you’ve established your monthly net income. They’re tools for creating a budget to determine how much you’re going to spend among a variety of categories.
BUDGETING TOOL EXAMPLES:
Worksheets: A budget worksheet is handy for projected household monthly expenses. Calculations are done automatically due to a built-in formula. Just fill in the blanks for the most common household expenses specified to see if you’re reaching your budget goals.
WHAT IS A BUDGETING SPREADSHEET
A budget spreadsheet is a pre-built, intelligent and interactive budget calculator in Excel. Its extremely user-friendly and does the calculations for you with more personalized expense categories than many of its peers. Above all, the spreadsheets built-in formula guides you through the budgeting process.
TYPES OF BUDGETING SPREADSHEETS
- Google Sheets: This is a cloud based spreadsheet software extensively used to create a budget. It also generates graphs and charts to display the visual impact. If you are familiar with Excel, you’ll feel comfortable using Google Sheets.
- NerdWallet spreadsheet: This online spreadsheet helps people make, compare and manage a range of financial products from banks.
- Mint Lifestyle budget: These budget templates allow you to simplify your budgeting exercise, giving you a glimpse of your income and spending. As a result, you can see what’s happening in all areas of your finances.
To help with creating and managing a budget. Of course, there are various budgeting tools, apps, and software available. Many programs have an option to link the budget to your bank and credit card accounts. As a result, you can track activities in your accounts in real-time. Once you’re close to reaching your set goal, the program sends alerts. In fact, many apps include charting and graphing capabilities which can display your spending over time.
BUDGETING SOFTWARE EXAMPLES INCLUDE:
- Mint app. With Mint, you can control your finances in a central place. Mint offers a budget creator and tracking feature that is simple to use. For the most part, it tracks your bank and credit card accounts. Additionally, it also tracks loans, mortgages, investments, and property. Particularly, it pays attention to your assets then displays if there’s a change in net worth.
- Fudget is a free and simple app that tracks your expenditures against what you earn. There are no categories to maintain, no charts or graphs to interpret and no learning curve. It creates a simple list of your monthly income and expenses.
- You Need A Budget. YNAB is a personal finance software based on the envelope budgeting method. The software runs on Windows or Mac computer and its cloud-based. As a result, it has the ability to automatically update your monthly bank accounts and credit cards monthly transactions.
On balance, the 50/30/20 budgeting method provides a solid point of reference for future net worth growth. Unquestionably, a great personal finance tool that acts as a starting point for getting your finances in place. Besides, it is flexible enough to be tweaked to fit your circumstances, which helps you to get started on crafting your budget.
To sum up, your initial task should be to establish your net income and total expenses, once it’s resolved then categorize your money into the 50/30/20 budget. Thereafter, you’re on your way to financial prosperity.
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I’m an extreme personal finance enthusiast and have been working in the financial industry for over a decade. The blog was started to further explore and share personal finance knowledge with the world.
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