This post is part of an ongoing series called “Deconstructing Financial Rules Of Thumb,” where I break down generally accepted financial principles and give you my opinion as to if they are worth following.
Budgeting… One of the most exciting words in the English language!
Oh, what, you’re not jumping out of your seat, eager to hear what’s coming next?! Haha
I’ve written about ways to save more money on this blog, but creating an actual budget can be a bit more intense.
There are many opinions on the best way to do this, and today we’re going to discuss a popular one known as the “50/30/20 Rule.”
THE 50/30/20 RULE
This is a rule designed to help you create a budget. It states that you should allocate 50 percent of your income toward necessities, like housing costs, bills, etc. 20% should be allocated toward financial goals, like saving up an emergency fund, planning for retirement, or paying down debts. And finally, 30% should go toward any of your wants, like entertainment and vacations.
The simplistic nature of this principle is one of its biggest advantages.
If you’ve read any of my past articles, you’ll know that I’m a big fan of simple concepts that are easy to implement. This principle allows you to avoid combing through all of your bank accounts or doing any serious calculating for future goals.
Also, the fact that there are only 3 main buckets you are putting money into helps to keep things simple.
The difficult part can be when trying to separate needs from wants.
As humans, we have a funny way of tricking our mind into thinking that a want is a need. You have to really ask yourself which expenses fall into which buckets and make sure you’re not gaming the system.
Another hiccup in this principle is the fact that it’s based on percentages. That certainly makes it easier to implement over a large number of people, but what if you are not earning a high income but you live in a high-cost area?
Being able to stick to just 50% for necessities can be difficult. Just ask anyone who lives in a major city like New York or San Francisco. The rents in these cities have skyrocketed in the last 10 years, all but ensuring that the average person is going to spend more than 50% on their necessities bucket.
Percentages are a quick hack to creating a budget, but they aren’t realistic because the cost of things aren’t based on a percentage of your income; they are based on where you live and the cost of those products.
You see this same problem happening in real estate analysis. Some people use a percentage of the gross income from a property to estimate the cost of maintenance and repairs, but those costs have to do with the area you live in, not the level of rent you’re getting.
In the end, I’ll always say that the best way is to run the actual numbers personal to you. That is the best way to figure out your particular budget.
An easy way to do this is to sign up for an account aggregation tool like mint.com that will help create a dashboard for your savings and spending, and will break down where your money is going.
If you want to start with these percentages, that’s fine. But I’d break it down into what the actual dollar amount will be for you in each bucket and then do a quick analysis to see if this is feasible.