If you ask your family and friends how they budget their finances, you are likely to get different answers. In my experience, there is no singular method that works for everyone. However, there are some guidelines that help make the process easier.
The 50/30/20 budgeting guideline is a great starting point if you want to simplify how you track your money.
In this article I will talk about the strengths and weaknesses of this budgeting method.
What is the 50/30/20 Budget?
The 50/30/20 budget breaks your money up into three categories: essential expenses (needs), non-essential expenses (wants), and savings.
Budget 50% toward your needs
According to this guideline, 50 percent of your take-home pay should be budgeted toward necessary bills that pay for your food, shelter, and transportation (needs)
Think about the most essential expenses in your life. This typically includes mortgage or rent payments, car loan or lease payments, food, student loans, insurance, utilities, etc.
Budget 30% toward your wants
Based on this guideline, you can allocate 30 percent of your take-home pay towards non-essential items (wants).
A want is any item or service that is not needed to survive. This includes cable or streaming services, gym memberships, dining out, vacations etc.
The line between a need and a want can be hazy if you spend money on expenses that you may consider essential, but in reality, you could live without. An example of this would be if you decide to lease a luxury car instead of an economy one. Technically, the difference in cost between these two options is a non-essential expense.
Budget 20% toward savings
After accounting for your needs and wants, this guideline stipulates that the last 20 percent should go toward savings. This can include building an emergency fund or investing if applicable.
Most financial advisors recommend that people save about 3-6 months’ worth of expenses in their bank account to cover any emergencies
Once you have your emergency savings built up, you can have some of your money go toward investing. For example, if your employer offers a 401(k), which allows you to defer taxes on your investments until retirement, you should consider contributing to this plan. This is especially true if your employer offers a match for your contributions.
Note that there are other vehicles you can use to invest for future goals. I will discuss them in a future article.
The 50/30/20 budget guideline is great for beginners because of its simple structure.
The harder alternative would be to track every expense as its own category. For example, budgeting $5 a month for toothpaste and $10 for shampoo. In reality this would be too tedious for many as most people are not extremely intentional with their spending.
This budget strategy allows for flexibility in spending.
For example, if someone lives with roommates, they may have more dollars to go toward non-essential expenses or savings. On the opposite side of the spectrum, if someone spends little on non-essential items, they will be able to save or invest more of their dollars.
Although this budget’s flexibility is a positive, it may also be its biggest limitation due to its vagueness.
First, this budget makes it easy to hide bad spending habits and may encourage you to make unnecessary purchases as long as you meet the percentage guidelines. For example, if you are a high earner, spending 30 percent of your income on wants can add up to a lot of money that could be better spent elsewhere. Also, if you are trying to get out of debt, you may not be encouraged to pay it off with this budget strategy.
Second, this budget makes savings an afterthought. Although saving 20 percent of income is admirable, this budget prioritizes wants over emergency savings or retirement planning. This may create a false sense of security. Depending on your goals and time horizon, saving 20 percent of net income may not be enough.
The 50/30/20 budget guideline is a good starting point to get a handle on your financial situation.
However, everyone’s budget is different because everyone’s financial situation is different. Therefore, not everyone can fit in the same 50/30/20 box. As a result, you must customize your budget to fit your financial goals and changing life circumstances.
If you are working with a financial professional, I recommend talking with them about your budget so you can get a third party opinion.