If you have issues with managing your money, especially the money you take home every month in your paycheck then the book titled “All Your Worth; The Ultimate Lifetime Money Plan” by Elizabeth Warren, should be relevant to you.
This book describes the “50/30/20 budget rule” which was made popular by Elizabeth Warren and her daughter Amelia.
You divide your after-tax income into three main categories of needs, wants, and savings. You allocate your take-home funds into these categories at 50%, 30%, and 20%, respectively.
As a practical and simple example, let us say your after-tax income is $1000. You then allocate 0.5 * 1000 = $500 into the “needs” category, 0.3 * 1000 = $300 into your “wants” category, and finally 02. * 1000 = $200 towards your ‘savings” category.
This example simply explains the “savings rule 50 30 20”. You plan your monthly budget based on the percentages recommended by Elizabeth Warren, initially in 2005.
Needs Category – 50%
Every month, you need to pay for certain expenses that are compulsory. There is no escaping these payments as they are necessary to sustain life on a day-to-day basis. This is the “must-have” and the “must-do” category.
These payments could include:
- Food – basic groceries, nothing fancy or overly expensive
- Clothing needs, again no fancy expensive brands
- Shelter – mortgage and property-related tax payments, rents, repairs, and insurance payments
- Healthcare treatments and medical prescriptions
- Utility payments for electricity, gas, water, trash, sewer, internet connection, and heating
- Minimum monthly payments towards credit card debt and personal loans, and other loans as applicable to you
Do not include dining out at your favorite restaurant, subscriptions to HBO or Netflix, and visiting Starbucks. You should keep an eye on your needs’ expense, as all your obligatory payments should be within half of your after-tax income.
You should take appropriate measures to cut down on unwanted needs if you discover that your funds’ outflow towards “needs” payments exceeds more than 50% of your income before tax. Using public transportation to work, carpooling, and cooking at home instead of eating out, are some habits you can inculcate to lessen your “wants” category expenses.
Wants Category – 30%
Any expense of yours that is strictly non-essential, that you can actually live without, falls into this category.
Most Americans need to change their mindset about the things we consider as “want” but are not necessary for us to live. It is easier to change our list of “wants” if we take the time to study the lives of most people in third-world countries. You see, most of the “needs” that are so essential for them to survive in life are found in our “wants” category. Is that not unfortunate?
For example, some of the things we “want” but are optional are cable TV, movie streaming services, unlimited data on your mobile, new furniture, frequent vacations, membership in gyms, very fast internet service, and tickets to the game instead of watching the game on TV.
These are things that should be considered avoidable expenses. They can directly contribute towards the percentage decrease of your “wants” category if you can change your lifestyle.
If you were planning on buying yourself a set of wheels to drive yourself around, then choosing an economical Toyota car instead of a very expensive Mercedes will contribute towards decreasing your “wants”. Choosing to eat a cheaper hamburger instead of a costly steak dish can satisfy your hunger and save your money. This is all about driving down your “wants” and increasing your “savings” category.
Savings Category – 20%
You need to allocate 20% of your after-tax or net income to this category. The savings category is all about putting money aside into a bank account as emergency funds. It is advisable to keep at least 3 months of money savings on hand, like emergency funds, in case something unforeseen or unexpected happens like losing a job.
If you ever dip into your emergency funds then it is critical to replenish this account at the earliest opportunity of receiving any extra or additional income. You can also make extra payments towards debts that are over and above the compulsory minimum payments, of the “need” category. This will help you decrease the overall future interest payable, as well as the principal that you had originally borrowed.
You can make IRA contributions into your retirement funds, and also invest in a mutual fund or the stock market. This way you can focus on building your retirement savings and fulfilling your investment goals.
Why is Saving Money so Important?
Every month, you need to pay for certain obligatory expenses, and this is good as these expenses enable us to have a life. But there are quite a few expenses that categorize as our “wants” which are definitely not our “needs”.
As Americans, we need to understand the paradoxical situation we are in. As a nation, the truth is that we have failed, and miserably so.
Do you know that our nation is at extremely high levels of debt? Also, that as of the beginning of last year, we were $438+ billion in debt, due only to the use of our credit-cards.
This is money we don’t have, that we are spending to get things we “want” but don’t “need”, on credit. Wow! Swipe your way deeper and deeper into debt. How bad can it possibly get?
What percentage of your after-tax income do you habitually save? It is never too late to start. The savings rule 50 30 20 can definitely start you on the road to good financial planning with a long-term benefit of getting you out of debt by decreasing your “wants”, servicing your needs, and saving money in the process.
The planning will encourage you to build up your emergency and retirement fund accounts that will be a life-saver if unexpected costs come your way. Things like unexpected medical expenses or sudden job loss, or any other situation requiring funds can hit you at any time. It is always good to be prepared, in advance.
The Takeaway from the 50 30 20 Rule for Budgeting
We do go through our lives with a lot of uncertainties. The “What if” question and the statement “If only” are always in our faces, more so, when we are in situations of uncertainty, and lack financial security, in life.
It is true that saving money is difficult, especially, when you are living on a small income as most middle-class families, in America, do. Unexpected expenses do come into our lives. This is Life. If you follow the “Savings” rule 50 30 20, chances are, you will at least have a plan to manage your after-tax income.
You can learn to channel more of your after-tax income to retirement and emergency monies if you find that your wants to be higher than 20 to 30% of your after-tax income. We have to personally inculcate habits to discern that not all of our “wants” are “needs” and thus learn to save on unwanted and unnecessary expenses.
Lastly, we cannot live in a perpetual state of being unhappy and unfulfilled, in life. After all, is said and done, we have only one life. So, balancing our after-tax income, on the one hand, and our wants, needs, and savings, on the other will help us get the best bang for our buck, in this life.