Many people will say that budgeting is a tedious task, but it doesn’t have to be. In fact, the right way of looking at budgeting can make it an enjoyable process. Budgeting your money is one of the most important things you can do for yourself. Not only does it help you save up for emergencies such as car repairs or medical bills, but it also helps you build up savings so that when life throws curveballs in your direction, you are prepared to deal with them without having to go into debt.
Understanding the Importance of Financial Management
Budgeting may seem like something difficult at first, which is why many procrastinate on doing this task until they run out of money or there’s another emergency in their lives. But if done correctly, budgeting can actually help you take control of your financial situation.
All you need is the 50-30-20 rule to start budgeting effectively right now. Here’s how it works:
You first want to identify your fixed costs or necessary things regardless of income, which include rent or mortgage payments, utilities, transportation, and insurance.
Needs vs. Wants
This is the most challenging part of budgeting because we tend to put things in this category that aren’t truly necessary, such as cable television or a cell phone plan with unlimited texting.
In order to get these spending numbers down, you need to question everything you spend money on whether it is a necessity. You may be surprised to find that you don’t need as many “luxuries” as you thought you did.
Make sure that you have a clear idea of what you need, what is truly necessary for your health and well-being, and what is just aesthetics. For example, getting new dental implants is necessary because it has an effect on your appearance and self-confidence. Getting new bling, however, is a want and not a need. It’s something you can have, yes, but you can put it off until such time that you have enough savings to afford it.
Next, identify your variable costs or those things which fluctuate with income or spending such as entertainment and dining out. Then determine the percentage of income you’ll spend on these categories. If you plan to increase your discretionary spending next month, put a placeholder in for this so that you’ll remember to increase the budgeted amount.
Finally, pull your income numbers and plug them into the 50-30-20 template. This is how it works out mathematically.
- 50% of your after-tax income should go toward fixed costs (rent/mortgage, utilities, etc.)
- 30% of your after-tax income should go toward variable costs (entertainment, dining out, etc.)
- 20% of your after-tax income should go toward savings, debt repayment, and investments
Budgeting using the 50-30-20 rule
By calculating what percentage of your money goes to each category, you’re forced to make choices about where you want the most of your spending to go. If rent is your biggest monthly expense, then you should aim to have at least 50% of your take-home pay going toward this.
Your savings and debt repayment portions should first go toward investments or reducing credit card bills or other high-interest debts. By implementing the 50-30-20 rule, you’ll automatically know how much to spend in each category to reach your financial goals.
If you have a large debt load, then aim for having 20% of your income going toward debt repayment until this is paid off before increasing savings and discretionary spending. This will help you stick with budgeting and give you a sense of accomplishment as the first goal is met. Then once you’ve paid off the debt, increase your savings and discretionary spending amounts.
Why follow this template?
The 50-30-20 rule is an easy way to budget. It tells you exactly how much to put toward your savings and your living costs each month. It considers all of your income from both fixed and variable sources, then calculates a realistic percentage for each type of expenditure. It makes it easy to determine if you’re overspending in a particular category and helps you see where you can cut back so that your savings goals aren’t out of reach.
Here’s an example:
Let’s say we have $2,000 per month in after-tax income to spend on rent or mortgage payments, transportation, utilities, and food. Using these numbers:
$2,000/mo = $16,667 per month (total income)
50% of $16,667 = $8333.33 for rent or mortgage payments
The 50-30-20 rule says we should be spending 50% of the after-tax money on fixed costs like rent or mortgage payments.
30% of $16,667 = $5,001 for transportation
20% of $16,667 = $3,334.33 toward all other expenses (utilities and food)
The 50-30-20 rule is a great way to keep track of your spending and make sure you’re saving enough for the future. Make it a monthly practice before making any payments or transferring money into various accounts so that you can budget out what goes where.