If you’re just learning to budget, the 50/30/20 formula is a great place to start. It helps you break your budget down into things you need, things you want, and put a little aside into savings. Using this formula with your current income will help you make good money decisions about what you can and can’t afford so that you stay out of debt.
It’s not hard to understand or get started. The first thing you need to do is create a spreadsheet listing all the things that you are now spending your money on every month. Be honest about it. Don’t leave out your Netflix subscription or morning latte just because they only cost a few dollars. You need a complete account of your spending to ensure the best results.
Now that you know what you spend on a monthly basis, use these steps to create your budget:
First: Calculate Your Income After-Taxes
This is the amount you deposit every paycheck, the money you actually have to work with. If your work doesn’t offer a regular paycheck, average the last 3 months of your income to figure this out.
If you have an deductions from your paycheck like health or life insurance, 401K contributions, or any other deductions, add them back in to your overall monthly income.
Second: Set Your “Needs” Limit To No More Than 50 Percent
What do you really “need” and what do you “want? This can be difficult to assess. Here’s how to figure it out: any monthly bill that you can eliminate with only a minor inconvenience, like your cable bill, is a want. You won’t go hungry or be homeless if you don’t have cable, it’s a luxury.
But any monthly bill that would impact your health or the quality of your life, like electricity, is something you need. If you have to make a payment to avoid going into debt, like a credit card or loan payment, it is also considered a “need” because not making it would negatively impact your credit.
Review your current budget and figure out how much you spend on your “needs” (food, rent/mortgage, utilities, and health insurance). The amount you spend on these things each month should be no more than 50-percent of your monthly income.
Third: Your “Wants” Should Be No More Than 30 Percent
Before you get all excited thinking that you can spend 30% of your income on the things you want, remember how strict the definition of a “need” was. Your “wants” should include the things you still want to keep around after your “needs” are met, like your cell phone plan or your cable bill. After that, anything else like a shopping spree or dinner out qualifies as a “want.”
Fourth: Save at Least 20 Percent or Use It For Debt Reduction
Set aside at least 20 percent of your income for reducing your debts or starting a savings account. If you have a credit card balance, the minimum payment each month is a “need”, anything more is debt reduction so it qualifies in the 20 percent savings. If you have a mortgage or a loan of any kind, the minimum payment is again a “need” and any extra payment counts as debt reduction. If you have managed to pay down all or most of your debt, you can use this 20% to start or add to your savings or any investment accounts.
The 50/30/20 budget system is a great way to get started budgeting and determine if you’re overspending in any area of your life.