When you've put together a budget, you might think that you have a good grasp on your finances. However, knowing where you've spent your money is only half the story. The other half is knowing how your funds should be allocated.
That's where the 50/30/20 budget comes in. It was co-developed by Senator Elizabeth Warren in her book “All Your Worth: The Ultimate Money Plan,” and it's become very popular in the world of personal finance.
50% for Needs
The largest category in the 50/30/20 budget is for needs, which should take 50% of your income. Your needs entail things like rent or mortgage payments, auto loan payments, health insurance, utilities and groceries.
If you're not sure whether or not something is a "need," ask yourself if not having it would severely impact your quality of life. Not being able to pay for cable TV wouldn’t seriously impact your quality of life. Not being able to pay for prescription medication, however, would.
30% for Wants
The next category is for wants. You should spend about 30% of your budget here.
Remember that "wants" doesn't necessarily mean "extravagances." In this case, it means "personal preferences." Sure, you can use that money to go to the Bahamas if you wanted to, but you'd have to ignore the other items you might also like in this category, such as a cell phone plan, Internet bill, eating out, books and a gym membership.
20% for Savings
The final category is savings. You should put 20% of your income in this category. While an emergency fund is definitely part of the savings category, it also includes savings plans, such as an IRA or 401(k), as well as any debt payments you have to make.
Putting 20% of your income toward savings is a more aggressive rate of saving than other financial experts recommend, but it offers fantastic benefits. You'll be able to pay off debt faster, amass a reasonable emergency fund sooner and start putting money toward your retirement sooner, which will give you a huge financial advantage.
One of the nice parts about the 50/30/20 budget is that it can scale to almost any salary, thanks to the fact that it uses percentages instead of solid numbers. This means it's an ideal model for people ranging from someone with their first entry-level job to someone planning on putting on a down payment for a second home.
However, you should remember that this budget may not perfectly fit your current financial situation. If, for instance, your needs take up 60 percent of your budget, you may have to reexamine how much money you want to put into savings and spend on wants.
The main point of the 50/30/20 budget isn't to make you feel trapped or force you to sacrifice things that may significantly improve your quality of life. Instead, it should help you determine what is essential, what isn't and help you make the best possible financial decisions.