How the 50/30/20 budgeting rule works – and can help simplify the way you spend money

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A household budget can help you stay on top of bills, pay off debt, save for retirement, and other long- and short-term financial goals. But there are many ways to do this.

A popular budgeting option is to follow the 50/30/20 rule, which requires you to allocate a certain portion of your income to savings, wants, and needs. This method is also called the “balanced money formula” because it can help you find a healthy balance between saving and spending.

What is the 50/30/20 rule?

The 50/30/20 rule is a simplified budgeting method designed to help you better manage your expenses while saving money for the future.

The rule comes from a book called Your full value: The ultimate lifetime money plan, written by Senator Elizabeth Warren and her daughter Amelia Warren Tyagi. It was published by Simon & Schuster in January 2006 and was a New York Times Best seller.

According to the 50/30/20 rule, you should spend:

In the book, Warren and Tyagi call the strategy a “simple, direct, effective” strategy to help you find financial balance, build wealth for the future, and ensure “there’s always enough of each of the three categories.”

It can also be a good strategy for budget novices, according to Jordan Hanson, a board-certified financial planner at HCR Wealth, a Los Angeles-based financial planning and wealth management firm.

“Anyone who is just getting into budgeting and is looking for simple rules or high-level guidelines can benefit from using the 50/30/20 rule,” says Hanson. “This rule is best applied when a budgeter is focusing less on the individual items in their budget and more on the big picture.”

How to create a budget using the 50/30/20 rule

Creating a budget based on the 50/30/20 rule is not a one-time process. You look at your income, assess your current spending patterns, set goals, and then periodically adjust your budget. Here’s how to get started.

1. Calculate your after-tax income

The first step to creating a 50/30/20 budget is to determine your after-tax income — how much money you’ll bring home after taxes. If you have a traditional job where your employer writes paychecks and regularly deducts taxes and Social Security, Hanson says, “You can look at your most recent paychecks and calculate a monthly number.”

If your employer deducts health, life, or disability insurance premiums, be sure and include them back. You’ll include these costs later in your “must haves” category.

If you’re a contractor, freelancer, other type of non-traditional worker, or self-employed, you may need to check your bank account instead. Add up all the deposits for the month — from jobs, gigs, clients, etc. — then subtract the amount you have to set aside for taxes. You can look at last year’s tax returns to get a good overview.

You should also make sure to include any additional income you may receive, such as child support, tips, commissions, and spousal support. If these cause your income to fluctuate, you can add up a few months of income to get a rough average.

2. Evaluate recent expenses

Next, it’s time to get a handle on your household expenses — and evaluate how they fit into the 50/30/20 method.

“Review your spending for the previous month,” says Hanson. “Then assign each expense to one of these three categories — needs, wants, and savings and debt.”

It sounds simple, but you may have hundreds of issues to sift through — and some may not be clearly categorized. If you need help, see the following under each section: “all your worth“:

must haves

  • Housing

  • Utilities

  • basic food needs

  • Telephone and internet service

  • Medical supplies

  • insurance

  • transport

  • childcare

  • property taxes

  • Legal obligations, such as child support or child support

  • Contractual obligations/payment plans (gym memberships, equipment payments, etc.)

  • Minimum loan payments (student loans, car loans, etc.)

Savings/Debt

  • Monthly contributions to pension accounts

  • Other savings or college account contributions

  • Additional debt payments (beyond the required minimum payments)

Want

Once you’ve added up last month’s expenses, you can determine how much of your income goes into each category — and more importantly, whether your current expenses fall within the 50/30/20 rule or if you need to make any adjustments. There are also calculators, like this one from Intuit, that can help with this step.

3. Make a plan

If your current spending habits and spending don’t quite align with the 50/30/20 rule, you need to make some changes. This may include reducing your “want to” spend or finding places to reduce “must have” costs, perhaps by changing your insurance plan or refinancing your mortgage.

Here is an example:

  • Income after tax: $5,000

  • Must Haves: $2,500 (50%)

  • Want: $1,500 (30%)

  • Savings: $500 (10%)

In the scenario above, you’re right on track with your must-have spends, but the others are out of whack. You could look at your spending in the Wishes category over the past few months to identify some potential areas to save.

To make sure you’re not spending more than you should in each category, you can also try splitting your funds into different bank accounts — one for each category, according to Faron Daugs, a certified financial planner, wealth advisor, and founder of Harrison Wallace Financial Group.

“This helps avoid the risk of funds being used for ‘wants’ before the actual ‘needs’ of the household are met – which can happen if budget funds are mixed up,” says Daugs.

Daugs also recommends segregated accounts — ideally with direct deposits — for your savings, investment, and debt-clearing goals. This automates your contributions and helps you avoid using those funds for ‘wishes’ as well.

4. Reevaluate regularly

As you begin your budgeting journey, go through and categorize your expenses each month to ensure you’re still on track with your 50/30/20 goals. “As you get more and more comfortable with your budget, you can review and reassess it less frequently, maybe quarterly or semi-annually,” says Hanson.

Budgeting apps like Mint and YNAB can help you review your progress and even track and categorize your expenses for you. The Consumer Financial Protection Bureau (CFPB) also has free fillable worksheets you can use.

Once you’re comfortable with your budget, Hanson says annual reviews should only be necessary.

“The goal is that you can automate your finances to the point that you don’t have to review your budget more than once a year,” adds Hanson. “At this point, you would also only reevaluate your budget if a major event occurred in your life that resulted in a significant change in your income or expenses.”

take that away

The 50/30/20 system can be good for beginners and big budgets, according to experts. But if you’re looking for other options, there are many budgeting strategies to explore, including the envelope system, the pay-yourself-first budgeting method, and the 80/20 budget. Consider consulting a financial professional or credit advisor if you need help choosing the right budgeting strategy.

This story was originally featured on Fortune.com

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