How does one make a budget? The short answer is that it depends. Not everyone is going to spend and save the same percentage of their income each month. However, deciding upon a feasible plan to allocate your monthly spending is important, and something that everyone should be doing once they receive an income. Currently, Americans have one of the worst savings habits in the world, demonstrated through the high average retirement age of 62. This means that knowing how much money to save as well as how much to spend are both crucially important to financial well-being. One consistent way to ensure financial security and freedom is through the 50/20/30 rule.
The 50/20/30 Rule
When you start looking at your budget, you should follow the simple 50/20/30 rule. Spend 50% of your income on necessary expenses, 20% on savings, and 30% on discretionary goods and services. This layout will give necessary flexibility, but also a good baseline to start your budget from.
- 50% – Necessary expenses include rent, car payments, and groceries. These expenses are, by nature, going to take up the largest chunk of your budget.
- 20% – Money that is saved should go to various different savings and investment accounts to maximize the return on your savings. After all, that money is useless if it isn’t being put to work.
- 30% – Discretionary goods are goods and services that you want to buy. These include clothes or a gym membership. These types of products are not necessary, but purchased through a consumer’s decisions
Why It Works
You’re probably thinking to yourself, “why do these specific values work?” This is a good question. These values are seemingly arbitrary; they don’t adjust to context for different situations. You would be correct in thinking this way. The 50/20/30 rule is not meant to be followed to the penny, but in fact adjusted to different financial realities. Suppose you have a lot of college debt in addition to the normal necessary expenses such as car payments and rent. That college debt has not been factored in to the 50/20/30 rule. Thus, you are going to have to adjust your budgeting plan. Perhaps a 55/20/25 rule would suffice. Less money should go to discretionary spending, and more should be allocated to necessary payments.
The 50/20/30 rule has been praised by experts, and still remains one of the most popular and successful methods out there. It was created by Harvard economist Elizabeth Warren and her daughter. And most experts agree that at least 20% of your monthly income should be saved.
It is important to note that are many other budgeting methods out there, including the much simpler 80/20 model, which eliminates the need to differentiate between wants and needs. The only thing you should focus on is saving 20%, and using the rest on the other spending.
The hardest part of budgeting is actually following the budget. It is easy to set goals for yourself, but to follow them is the hardest part. To implement a budget, pick one of the following methods:
The Old Fashioned Spreadsheet Budget
To use this budget, simply print out some budgeting worksheets from online such as this one or keep a log in Microsoft Excel. Then, choose one regular spending months out of the year, and track all of your expenses. Keep all of your receipts, track your monthly income pulled in, and write it all down in the spreadsheet to the nearest penny. Make sure that all of your expenses are in neat columns, so everything is easily organized and understandable.
Lately, budgeting technology has exploded, providing new alternatives for keeping track of budgets. Also, new technologies can link credit cards to your phone, allowing you to easily track all purchases.
The best budgeting app on the market by far is called Mint. It is an application released by Intuit that can manage your money, including your budget allocation. Your credit cards and bank accounts can be linked to the app through your phone, allowing you to easily centralize all of your expenses.
Each method of budgeting isn’t going to work for everyone. For some, perhaps sitting down at a table, looking over all expenses, and recording numerical expenses each week is best. For others, a budgeting app will allow them to see their spending habits each time they make a purchase, and will also allow them to adjust accordingly. The goal of budgeting is not to use “the best” strategy but rather to use what benefits you the most. There is no clear-cut budgeting strategy. That said, using a budget is much better than not using one at all!