Assuming that you’re already aware of the importance of budgeting, we can progress to a simple but powerful budgeting approach. The 50-30-20 budgeting approach recommends spending 50% of your after-tax income on needs, 30% on wants, while saving the remaining 20% each month. The technique is easy to follow and can help you achieve your financial goals by effectively managing your finances. But how does one distinguish needs from wants?
Needs, Wants, and Savings
In budgeting, needs are those items or expenses that are essential to your everyday life. Spending on these types of items is a necessity. The bills that you can categorize as ‘needs’ can include food, healthcare, transportation, utilities, among other indispensable daily expenses.
On the other hand, wants are those expenses that are not necessities, but make your life comfortable and more enjoyable. In other words, any other expenditures other than your basic needs can be defined as wants. Eating out, holidays, buying a new party outfit, or spending frivolously on fancy gadgets are some of the examples of wants. Without wants, you’ll still survive on your fundamental “needs”, but life may be a little bit dull.
Lastly, the approach suggests you should save and contribute 20% of your income each month to your emergency and sinking funds, which will allow you to meet your planned and unplanned expenses.
Benefits of the 50/30/20 approach
Here are some of the primary reasons why adopting the 50/30/20 approach to budgeting can be helpful.
The 50/30/20 rule defines spending thresholds, and also sets a savings target for each month. This approach can help you to be more financially disciplined. By being more disciplined with your spending and savings, you’ll have a better chance of achieving your financial goals. If your expenses on ‘needs’ or ‘wants’ breach the established limits, you can easily identify the areas that need cost-cutting. That can help you achieve your 20% savings target to ensure you can handle the unplanned challenges that life throws at you, or to plan for a more comfortable retirement.
Humaniti can help you understand your spending in great detail. When you connect your financial accounts, we do the heavy lifting to automatically categorise your spending, so you can better understand your spending, and learn where you can save. You’ll be able to quickly identify any areas where your spending too much, and our subscriptions feature allows you to easily review your “wants”, so you can decide if they’re really necessary.
Most people do not budget their income and expenses because they associate budgeting with complex calculations. However, the 50/30/20 approach is an easy technique to create a simplified yet effective budget, that you can implement immediately to get your finances in order. By combining the approach with a personal finance and budgeting app like Humaniti, you can easily monitor your spending.
The 50/30/20 budgeting approach gives you leeway to spend on your wants, instead of restricting you to spend on just needs. It assumes and accepts that we all have wants, and that not all of us can, or want to live a thrifty life without expenditure on the things that bring us joy. This means you have greater freedom with your budget. By allocating a portion of your budget to ‘wants’, this can also help you to stay motivated, while allowing you to have some fun.
How to create a Budget using the 50/30/20 budgeting approach
You can create a budget based on the 50/30/20 budgeting method by following the steps below:
1. Determine your after-tax income
Step 1 involves determining your after-tax income. If you are employed and have a regular income, your take-home monthly salary will most probably be your net income, as taxes are deducted by your employer. If you draw income from other sources as well, you should factor that income in too. In the event you are self-employed, your income may be variable. Deduct all business expenses and taxes from gross income to calculate your after-tax income figure. By doing this for a broader period like 6 months or a year, you can then work out an average that you can use on a monthly basis.
2. Allocate your income using the 50/30/20 ratio
After calculating your monthly after-tax income (also known as your net income), allocate 50% of it to meet your needs such as groceries, utilities, and rent; 30% on your wants such as eating out, going on holiday or buying gadgets; and lastly, save 20% of your income each month. Consider setting up automated transfers to dedicated accounts for needs, wants and savings, aligned to your pay date.
3. Track your expenses
Key to this budgeting method is ensuring you track your expenses so that you don’t breach the limits you set in the previous step. You can use expense tracking features available in a budgeting app like Humaniti to make your life easier. Humaniti facilitates a Link, Learn and Earn approach. By linking your financial accounts, you can monitor your expenses in close to real-time, without relying on any guesswork. Learn where you are spending by using the automated insights and dashboard. They also offer the ability to take part in surveys if you choose to do so, which can boost your earnings (see point 1). By employing this method, you could be able to identify areas where you are overspending and make necessary adjustments.
4. Ensure you meet your savings target
Another way you can keep your spending within the limit is to meet your savings target as soon as your salary is credited into your account. Consider setting up a dedicated savings account and set up an automatic withdrawal equivalent to 20% of your monthly salary from your salary account to that account. That way you can avoid temptation to dip into your savings during the month, while shifting your focus to managing your needs and wants.
The 50/30/20 method of budgeting is a popular method that you can easily follow, and does not involve complex calculations. If you’ve previously struggled to budget, this approach may be easier to follow. Consider combining that budgeting technique with a personal finance app like Humaniti, to quickly understand your spending, and learn where you can save. Humaniti also offers a multitude of other features that can help take the headache out of finances by helping you to track your net worth, view your income and expenditure summary, and better understand your super.
* Disclaimer – the information in this post is general only and does not constitute financial advice.