Living happily and prosperously within your means doesn't require infinite patience, wisdom, self-restraint or mathematical brilliance -- all it takes is the ability to spend, save and repay in sensible proportions. If that's the ingredient missing from your current money management stew, then you could benefit immensely from something called the 50/20/30 budgeting method. Let's take a look at how this principle works -- and what it can do for your future financial health.
You may have heard the term "50/20/30" before. The method in question was so named by Senator Elizabeth Warren of Massachusetts in "All Your Worth: The Ultimate Lifetime Money Plan," a book by Senator Warren and Amelia Warren Tyagi. By separating their net (after-tax) income into three main "funnels" or categories, practitioners of this simple method find it much easier to see that their money goes where it's supposed to, instead of having unpredictable portions of it seemingly disappear into thin air every month. The three main expense categories include:
Some of the expenses that recur on a predictable basis are absolutely essential for maintaining your basic well being. Mortgage or rent payments, utility bills, groceries, medication, basic transportation costs -- these and other critical items help you fed, healthy, employed and safe. Minimum credit card payments also count, since making these payments can keep you from destroying your credit rating. You'll probably have little difficulty identifying these expenses. Devote fully 50 percent of your net income to these lifesavers to ensure that life's basic needs continue to get met, month and after month and year after year.
This category includes the money you put aside to deal with emergencies, plan for retirement, and pay off outstanding debts. If you try to cover these expenses by squeezing the odd dollar here and there from your total net earnings, not only will you probably fail to meet your savings and repayment goals, but you will also find yourself struggling to make your essential monthly obligations. Senator Warren recommends setting 20 percent of your net income aside automatically each month to cover ongoing savings and major debt repayment issues. You may find it slow going, but at least you'll know that you're making consistent progress in these areas.
This category surprises many budgeters, but it's just as important to their overall financial health as the other two. It includes all those things that make your daily life enjoyable without necessarily constituting a need -- such as restaurant meals, coffee or drinks with friends, movie tickets, and items to beautify the home. By devoting 30 percent of your net income to this general category, you eliminate the "evaporation" of funds that occurs when you unthinkingly spend money on these items without budgeting for them. You also know exactly how much money you can spend on these perks each month, which prevents splurges you'd later regret.
Unlike more granular budgeting methods that put a stranglehold on your spending behaviors, the 50/20/30 method gives you an extraordinary degree of flexibility and freedom. If you can remember three simple categories, place the correct percentages of after-tax money in those categories, and know which category a given expense belongs to, then you're on your way to a happier, more stable financial life!
William Reynolds is a freelance writer with expertise in issues of personal finance and more.
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