Here’s a synopsis of a simple, but effective, approach to budgeting.
For many people, getting better at budgeting is near the top of their New Year’s resolutions list. However, developing and sticking to a budget isn’t always a simple task. Creating complicated spreadsheets, learning budgeting software and dealing with spending restrictions — all of these things can end up derailing even the most dedicated New Year’s budgeter.
The Mechanics
Start by splitting your monthly income into three simple “buckets” or budget percentages:
- 50% for needs,
- 20% for savings, and
- 30% for wants.
Your goal is to spend only the money you have coming in each month. Try to wean yourself off of making purchases or payments on credit, if applicable. From there, follow these four simple guidelines.
1. Define Your Monthly Income
The term “income” refers to the money (after taxes) that you have available to spend each month. This might be based on your paycheck or some sort of freelance income after related expenses are paid. You might also include income from:
- A side job or money-making hobby,
- Investment income,
- Alimony and child support, and
- Government benefits.
Add up these sources of income. This is the amount you have available to budget each month.
2. Budget 50% for “Needs”
Your needs allocation should include required essential expenses, such as:
- Rent or mortgage payments (including property taxes savings if you don’t escrow),
- Utilities (including water, garbage, electricity, gas, cable and phone),
- Food (groceries only, not dining out),
- Vehicle gas, commuter passes and tolls,
- Home, auto and life insurance, and
- Clothing (within reason).
- Child support and alimony for those who must pay them.
The amount of your needs budget is easy to determine — it’s just one half of your available income. So let’s say your after-tax monthly income is $3,500. Your needs budget should be $1,750 (or less).
If you’re spending more than 50% on needs, think about trimming some of your fixed expenses. For instance, spend less on groceries with coupons and weekly specials, carpool to work with a friend or switch to a cheaper internet, phone or cable plan.
3. Set Aside 20% for “Savings”
Don’t ignore savings when you’re making a budget. Having some money tucked away in a savings account may make you less likely to go into debt to pay for a costly, unplanned expense. While you need cash savings available, you should also be funding a retirement account which you don’t touch.
The 50-20-30 budgeting approach suggests including any debt payments (other than your mortgage) in this 20% savings bucket. At first, this might not make sense. However, the idea is that after you pay off nagging debts (like student loans, car payments and credit cards) that money should go toward savings, rather than toward your needs or wants budgets.
So, if your monthly after-tax income is $3,500, you should save or pay off debt of about $700 each month ($3,500 times 20%). If you’re not meeting this goal, consider cutting costs in your needs and wants categories.
4. Limit Spending on “Wants” to 30% of Your Monthly Income
It’s smart to budget some money — even if your income is tight — for things you enjoy. Doing so may help keep you from experiencing “frugal fatigue” and blowing your budget altogether.
Again, assuming you have $3,500 of monthly after-tax income, you’re allowed to spend $1,050 on nonessential things you enjoy ( $3,500 times 30%).
Examples of wants include:
- Eating out and getting lattes from your favorite coffee shop,
- Gym memberships or CrossFit classes,
- Extracurricular activities for your kids,
- Vacations, and
- Entertainment, such as going to movies and downloading music.
- Clothing that is more want-based than need-based.
If you’re spending less than 30% on your wants category, are your needs and savings buckets too large? Be careful not to skimp too much on wants. Having this category may end up being the “secret weapon” that helps you stick to your budget.
Formula for Success
There’s a simple equation for developing a monthly budget that will last throughout the year: 50% plus 20% plus 30% equals a 100% doable monthly budget. If you want more details, a quick internet search for 50-20-30 should provide you with all you need to know.
