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By Kate Streit
You know you should stick to a budget, but it can be difficult to know where to start. The 50/30/20 budget has been around for a while but was given a new life when Senator Elizabeth Warren popularized it again in her 2006 book All Your Worth: The Ultimate Lifetime Money Plan. And it may be a great place to begin your journey toward financial health.
According to this strategy, 50 percent of your after-tax income should go toward necessities, 30 percent should go toward wants or “fun” spending, and the remaining 20 percent should be for savings and/or debt repayment.
Necessities include essentials such as housing, utilities and groceries. These fixed expenses are nonnegotiables, and if you have minimum payments due on loans or credit cards, those should be part of this category as well. The key is that these expenses cannot exceed half of your after-tax income, so if you’re struggling to stay under that limit, you may need to consider moving to an apartment with cheaper rent, or find creative ways to cut your expenses.
Your “want” money consists of all those things that are nonessential, but make life enjoyable: entertainment like your Netflix subscription and concert tickets, meals at food trucks or restaurants, and new additions to your shoe collection. It’s important to be honest with yourself about what constitutes a genuine need vs. a want. While it may be true that you need a phone to function in your daily life, your budget may determine that the latest iPhone is not in the cards right now.
The last 20 percent of your money should be allocated toward savings and debt repayment. This includes funds you set aside in a savings account for emergencies or to save toward a specific goal as well as contributions to retirement accounts like a Roth IRA, and money invested in the stock market. While minimum payments on debt should be part of your “needs” category, as falling behind on those can wreck your credit, putting any extra cash above and beyond the minimum toward your debt can be seen as a form of saving with this plan.
The 50/30/20 budget is an effective way to organize your money because it’s simple and easy to follow. The budget can also be tweaked slightly to meet your specific needs. For example, if you are able to keep your “fun” expenses even lower -- say, at 25 percent of your income, as opposed to 30 percent -- that means you can add an extra 5 percent onto your savings or necessities budgets.
Because this budget allows plenty of room for discretionary spending, you’ll never feel like it’s all work and no play. Much like a diet that’s too restrictive and doesn’t allow for a treat now and then, complicated budgets that demand you scrimp and save every penny you earn can leave you feeling deprived. Instead of bingeing on dessert, though, you may end up blowing your whole paycheck on something frivolous. Moderation is key with this budget, which means you’re more likely to stick to it.
The 50/30/20 budget does have its limitations, however. Some experts recommend that becoming debt-free should be your top goal before you tackle any other financial objectives. The budget also does not prioritize saving, which means you may come up short when unforeseen circumstances like sudden job loss hit.
While its simplicity is a big part of the budget’s appeal, its lack of specifics means you may lose sight of what’s really important to you. If there’s not a particular line-item on your budget for a big purchase to save toward -- like a new car -- you may be less motivated to do what it takes to get there.