The 50/30/20 formula or rule of thumb was written by Elizabeth Warren and her daughter Amelia Warren Tyagi, and published in the book they co-authored, “All Your Worth: The Ultimate Lifetime Money Plan.”
Now as with all formulas this wont apply to everyone but for those who can master this system you’ll be well on your way to budgeting heaven. This formula let’s you see if you’re financially balanced. So let’s get started.
1. Work Out Your After-Tax or Net Income
Your after-tax income is the amount you have left over after all the taxes have been taken out of your weekly/fortnightly wage. This is your net income.
If you have superannuation payments and other payments coming out of your pay before you get it then you need to add those back in as they will be added into a category further on in this article.
2. Calculate Your Needs to 50 Percent Of Your After Tax Income
Now here’s where you must know the difference between a ‘need’ and a ‘want’. A want is a payment such as your Foxtel bill. Eliminating this would be a minor inconvenience so it is a want. A need would be a payment would negatively impact your life such as electricity.
Needs include mortgage and rent, utilities, health care if you need it to survive, transportation, compulsory insurances, and basic groceries and basic clothing.
Wants are everything else: internet TV, mobile phones, haircuts, gym memberships, books and magazines, holidays, food and clothing beyond the basics required. You probably have enough clothes to last years anyway.
Now it’s time to review your family budget and see how much you are spending on ‘needs’ such as food, housing costs, utilities and insurances. The amount that you spend should be no more than 50 percent of your net income.Check out our budgeting page for excellent guidance.
3. Now We Need to Limit Your Wants to 30 Percent Of Your After Tax Income
This might sound sweet but you have to remember that things like your mobile phone plan, bought coffees/lunches and that Foxtel subscription are now in this category.
It’s time to take a look at how you can reduce your wants down to 30 percent of your net income. We have hundreds of ways to help you with reducing costs on the Money Savvy Mums website, check out a few ideas here to get you started.
4. Allow Yourself to Spend 20 Percent of Your After Tax Income on Savings and Debt Reduction
It’s important to get out of debt first. While you have debt, your main focus is to reduce and get rid of it — saving money is the secondary goal. When the debt is gone, then you can save.
Here’s where you need to add back your compulsory superannuation payments that automatically come out of your wage and any other savings money that comes out before you receive your wage.
Try to spend at least 20 percent of your net income repaying debts such as credit card debt, extra payments on your car or mortgage loans and then save the rest in an account purely for saving for a rainy day or a big ticket item you might want.
And that’s the principle of the 50/30/20 formula! We know this isn’t for everyone but it’s a good place to start when you’re looking for ways to help with your budgeting. Maybe you can work out a system similar to this one that suits your financial position.