New At Budgeting? Try this 50/30/20 Rule

The 50/20/30 Rule of Budgeting

When it comes to money, there are things that you cannot ignore, rent, food, retirement, down payment for a house, gym and members club subscriptions, the gifts, you name them. There are here with us and that is just the basic of adulting

When it comes to budgeting, you need to ask yourself where your money should be going. The answer to this question will vary from one person to another hence this more an intimate question that that person who will ever ask you if you are single, married etc.

First, I would like to congratulate you for having created your budget.  Right now you know the amount of money you spend in your house, your car, building up the emergency fund or even the retirement fund. The big question now becomes, how does your financial appropriation compare to how much you need to generally spend and save?

My personal favorite thumb rule for budgeting is the 50/30/20 rule of budgeting that was suggested by Elizabeth Warren and her daughter, Amelia Warren in their book, “All Your Worth: The Ultimate Lifetime Money Plan”

So, how do you follow this rule to ensure it gives you the best out of your budget?

• Determine Your After-Tax Income

The after-tax income is the amount that has in your paycheck after all taxes have been deducted; social security fund and also the national hospital insurance funds have also been deducted.

For salaried individuals, that after-tax income amount is easy. You will need to add back the health care, retirement contribution and any other amount deducted from your pay check.

For self-employed individuals, you will need to know after tax income is the gross income less the business expenses and less any amount that you need set aside for taxes

• Limit Your Needs to 50%

Remember step number 6 in my article on how to set up a budget? I talked about implementing, monitoring and adjusting your budget.

Take a look at your needs, these things like groceries, rent/mortgage repayment, utilities such as electricity and water, health insurance, car insurance just to mention a few. These monies that you spend on the needs should not be more than 50% of your after-tax pay as per this rule.

Before we can proceed, what is the difference between needs and wants? I can differentiate this with some good example, any form of payment or purchase that you can go without and cause you a minor inconvenience, e.g. pay TV, Back-to-School clothing unless it a torn or tattered school uniform is a want. For a payment that would majorly impact your quality of living such as electricity, water, prescribed medication, that is a need.

Countries that are big on credit scores you need to know that a minimum repayment on a credit card that you cannot ignore is considered as a need in this case. The reason as put by the Warrens is that this will affect your credit score negatively.

• Limit Your Wants to 30%

This sounds everything fancy, doesn’t it? It did sound fancy to me too. So right now I know you thinking, Hello shoes (we girls do love them shoes don’t we?) that fancy trip to Maasai Mara, or the beautiful beaches of South Coast, Mombasa, the fancy dinners and fancy hair styles, oh them hair extensions.

Hold Up! Remember our definition of needs and wants? That unlimited texting plan, the pay TV, non-mechanical repairs to your vehicle, getting your child that extra uniform just in case.

There are other times when a need can upgrade to a want. For example, Bread is a need but a biscuit is a want. Both are usually categorized as groceries but from the look of things, one is more of a discretionary need than the other.

Upon further scrutiny of your budget, you might find that you may be spending more on wants than you may currently think.

• Allocate at Least 20% on Savings and Debt repayment

You can spend a minimum 20% of your after tax income towards repayment of debt and also be saving for your emergency fund and even your retirement fund.

Say that you carry a credit card balance and the minimum payment, which is a need, is set at 50%, anything above that will be additional debt repayment and it qualifies to fall under this category.

In the case of a mortgage or a car loan, the monthly installment requirement is a need, any extra amount that you might decide to allocate to further pay them, that forms part of debt and repayment.

Remember, the rule might change depending on your level of income and where you stay as well. 

With time, we shall look at the various variations of this rule to help you meet your financial goals.