Coined by Harvard-educated bankruptcy expert Elizabeth Warren in a book she wrote with her daughter (yes, that Elizabeth Warren), this method of budgeting covers all of life’s necessities. It also provides a rule of thumb for an efficient allocation of your finances.
In a nutshell, understanding the 50/30/20 budgeting rule means spending 50 percent of your income on needs, 30 percent on wants and 20 percent on savings and investments.
Expenses associated with your very survival constitute needs in this instance. Mortgage payments (or rent), transportation such as car payments (or however else you might get to work), utilities, food, and grocery items, insurance, health care, and minimum debt payments are the key line items here.
Basically, anything that would infringe upon your ability to live, or have a negative impact on your credit score, should be considered a need. It’s all about ensuring a decent quality of life — based upon your income level.
Luxuries over and above what you need to live fall under this heading. These include choosing steak over hamburger, a Porsche over a Volkswagen, a Rolex over a Timex and first-class over coach — or even better, a no-frills airline.
It also applies to meals out vs. eating at home, expensive clothing and shoes, pricey plays and concerts as well as vacations, shopping sprees, boats and a huge home. With that said, if your budget allows you to do things big, more power to you.
Just avoid spending more than 30 percent of your income to have it like that.
Savings & Investments Explained
This category might seem self-explanatory but bear with us for a moment.
Yes, savings means establishing your emergency fund should you ever experience an interruption of your income stream, or an unexpected large expense. It also means a liquid savings account for larger purchases you can make with cash, IRA contributions, a mutual fund account, establishing a college fund for your kids and etc.
However, it can also mean debt payments. Now before you question us, you are remembering correctly; we did cover debt in the needs category. Go back and read it again though. You’ll see we said minimum payments on debt.
If you have a significant amount of debt, a smarter investment is to pay it off as soon as possible. Odds are you’re paying far more interest than you could earn with a savings account or an investment, so you’re actually losing money by keeping those debts around.
Flexibility Is Essential
If your debt is such that you need more than 50 percent of your income to cover your needs, you can always shave off some wants. That’s the first best place to start reallocating funds. After all, foregoing the other two categories could impact the quality of your life in a much more significant fashion.
It’s far better to bend in the wants category than it is to break needs.
Consulting a debt professional to go over your options for debt elimination can be helpful if things are threatening to get out of hand. The consultants at organizations like Freedom Debt Relief are trained to evaluate your situation and devise a plan specific to your needs, which may include some combination of settlement and consolidation.
The Most Important Consideration
While understanding the 50/30/20 budgeting rule is helpful, every spending plan needs one universal ingredient to be successful. Your commitment to keeping to the plan will make or break your success.
This is why it’s important to evaluate your situation carefully to ensure you can live with the plan you devise for the long haul. Keep in mind, it’s OK to be flexible and make adjustments as warranted. Just make it a point to stay with your plan until you achieve your goal.