Personal Finance and budgeting are topics where people always shy from.

Even though budgeting your money is really important, setting up a budget for the first time can be pretty scary.

So, how to budget the right way?

In fact, the rich and successful knows how to budget their finance really well.

Thus, I went on a journey to understand more about how the rich budget their money before they become successful.

Here I’ve created an easy beginners guide to budgeting using the 50/20/30 budget rule.

You will learn exactly the steps on how to create a personal or household budget from scratch.

Lets dive in!

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What is the 50/30/20 budget Strategy?

The 50/30/20 budget strategy or rule was commonly used by financial advisor and popularized by Elizabeth Warren in her bestseller book “All Your Worth: The Ultimate Lifetime Money Plan.” Elizabeth Warren co-authored this best seller personal finance book with her daughter, Amelia Warren Tyagi.

The 50/30/20 budget rule focuses on an allocation of your after-tax income on a set percentage on 3 important categories:

3 main categories are:

  1. NEEDS = 50%
  2. WANTS = 30%
  3. SAVINGS = 20%

“50/30/20 budget rule” get its name by the budget allocation of the 3 categories, needs, wants, and saving. It is one of the most effective budgeting techniques that is simple and suits most people.

The best thing about this budgeting method is that, you only need to do one simple task.

Stick to the plan!

Simply following this plan will ensure that you are always moving toward your financial goals.

Of course you can always do a bit of tweaking on the budget such as,

  • Increase the percentage you want to put in your savings
  • Reduce the percentage in spending on wants.

With each adjustment you will move closer to your financial goal.

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Step 1. Define Your Goals

First step in creating a budget. Identifying your goals is the most important of all in planning your budget. Because, you need to know where you are going before you can think of how to get there.

A person who just want to make a living will have different goals to a person who want to be financially successful.

How should you define your goals?

When defining your goals, be very specific.

You should not set vague goals such as, “I want to be debt free” or “I want to be rich”. Vague goals are the main reason that people are unable to meet their goals.

A vague goal is like the yearly resolution that we so familiarly promise ourselves year after year for the past 10 years.

When defining your goals always think SMART.

SMART stands for Specific, Measurable, Attainable, Realistic, and Time-bound.

Specific

  • Write your goal so it is very clear on what you want to achieve and specific
  • Example: I want to have money in my savings account to cover any unforeseen emergencies.

Measurable

  • How much do you actually need?
  • Example: An saving of $2,000 to cover the repairs of my broken window, and summer class for my 12 year old kid.

Attainable

  • Actionable steps where you will break down your goal into smaller steps to where each step will bring you closer to the goal. 
  • Example: How much will you need to save each month to get to $2,000?

Realistic

  • When setting goals being realistic makes your journey to achieving your goal much simpler.
  • For realistic, you may want to push yourself so you can grow, but not so much that the goal is simply not achievable.
  • Example: Saving $500 each month with a $3,000 monthly income is much more achievable than $500 each month with a $1,000 monthly income.

Time

  • All goals must have a due date. This have to be the date and/or time you have to achieve your goals. This helps to prevent you from procrastinating.
  • Example: I will achieve my goal in 120 days (4 months) from today at 12 noon.

A good example of a goal is as follow:

“I will have $2,000 in my savings account in 120 days at 12 noon to cover the repairs of my broken window, and summer class for my 12 year old kid by saving $125 dollar per week ($500 each month) with my current income of $3,000 per month”

Remember: Setting successful goals are set on things that you can control.

Other alternative goal setting methods to setting SMART goals are FAST goals, CLEAR goals and PACT goals. HQHire have some in-depth article on each of them.

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Step 2. Know Your Income and Expenses

Second step in creating a personal budget is to know your income and expenses. You’ll need to know how much are you actually earning and how much are you spending.

“Have you ever checked your bank account and keep wondering where is all your money?”

Like many others, we have asked this question ourselves too, it is always a mystery.

If UNESCO allows it, “mystery of the disappearing money” is probably the ninth wonder of the world.

Jokes aside, when creating a budget, you will get to understand the flow of your money.

A budget allows you to know where does your income comes from, and where are all your expenses.

Getting to know and understand your own income source(s) and your spending habits allows you plan ahead.

You can allocate your income into different categories, some into needs, some into wants, and the rest into savings.

What are the different sources of income?

The most common source of income for most household is earned income, but there are many different sources of income.

In fact, the wealth usually will have more than 1 source of income.

Here are the most common 7 streams of income.

  • Earned income: This is your day job and the most common source of income, which is also known as salary income.
  • Profit income: This is the income you earn though business.
  • Interest income: This is the income you earn through lending of your money to others or organizations for a certain amount of interest paid to you over a period of time.
  • Dividend income:  This is the money that is you’ve earn through distribution of dividend from the stocks you own.
  • Capital gain income: This is the money you get from the appreciation (increase in value) of an investment through selling of stocks or business.
  • Rental income: This is the money you get by renting out an asset such as your properties, room, or car.
  • Royalties income: This is the money you’ll get by allow others to use your original products, ideas, content, design, or process in return for a payment.

Example of a guy name John Smith:

John only have one source of income which is his daytime job as a car mechanic.

John earns $2,500 per month from his daytime job, and as a responsible citizen he pay his taxes of $500, and receives $2,000 after-tax.

John have a whooping $2,000 per month income flowing into his bank account.

Bottom line: John have a $2,000 take-home salary income.

Where are my expenses?

Secondly, you will list down all the different place where your money is spent, and finally decipher the mystery of where your money gone each month.

We will separate all your expenses into few general categories:

  • Food
  • Shelter
  • Transport
  • Utilities
  • Medical
  • Personal Care
  • Entertainment
  • Savings
  • Donations

Example of a guy name John Smith:

Shelter

  • John lives alone in a condo he rented including utilities fees in the prime district in the CDB area.
  • $800 per month; 40% of his income

Transport

  • He just brought the latest model of Tesla and is financing his car loan
  • $500 per month; 25% of his income

Food

  • John loved to get a cup of $5 latte everyday from his favorite cafe before work and during lunch ($10 per day = $300 per month). And he love to dine out occasionally.
  • $300 per month for the latte; 15% of his income
  • $400 per month for the food; 20% of his income

After calculating and listing down his expenses John found that his total monthly expenses as follow:

  • John spend $800 (shelter) + $500 (transport) + $300 (latte) + $400 (food) = $2,000 per month

With a take home cash of $2,000 and after all expenses, john left $0 for saving after each month.

He realized he need to change and have decided to create a budget plan.

Step 3. Developing Your 50/30/20 plan

Before we can develop our 50/30/20 budgeting plan, we need to identify the needs and wants.

So, let’s understand what is a ‘need’ and what is a ‘want’.

Difference between needs and wants

Needs are basic expenses which you cannot live without, thing we must have to survive, such as food, water and shelter. Wants are desires for goods and services we would like to have but do not need.

Needs vs wants examples

  • Living with a shelter above your head is a need, but living a in luxurious home with a pool is a want.
  • Taking transport to work is a need, but driving the latest model of BMW to work is a want.
  • Having a balance healthy diet is a need, but eating out in a fancy restaurant with a glass of 2014 Joseph Phelps Insignia is a want.

How to make a monthly budget?

Let’s use John Smith to illustrate on how he make a monthly budget.

Income:

  • $2,500 and $2,000 take home income after-tax

Expenses:

  • $800 per month for the condo locating in prime district; 40% of his income
  • $500 per month for the latest Tesla Model Electric Car; 25% of income
  • $300 per month for the latte every morning and after work; 15% of income
  • $400 per month for the food; 20% of his income

In order for John to create a budget of 50/30/20 he can do one of these 2 methods

  1. Increase income
  2. Reduce expenses
1. Increase income

He can take a part-time job or get promoted at work to increase his income.

Alternatively, he can try one of these few ideas where he can increase his income passively.

Read Also: Best Passive Income Ideas You Can Do Today

2. Reduce Expenses

If you cannot find ways to increase your income, or wish to reach your goal faster. Then you may want to find ways to reduce your current spending so you are able to put some money into savings.

Focus on reducing your wants.

Tips on how to spend less!
  • Buy essential during an offer or discounts
  • Change your cell phone plan
  • Get rid of cable TV
  • Get a roommate
  • Stop going to parties and get wasted, start reading books that will help you to grow
  • Exchange “wants” with friends/family
  • Avoid buying snacks and sugary drinks, as for our fractional character John, “Latte”.
  • Lastly, have the wants once a while after you accomplish each steps of your goals.
How we can help John to reach the 50/30/20 Budgeting Goal:

Income:

  • $2,500 and $2,000 take home income after-tax

Expenses:

  • Shelter: $800 per month for the condo locating in prime district; 40% of his income
  • Transport: $500 per month for the latest Tesla Model Electric Car; 25% of income
  • Latte: $300 per month for the latte every morning and after work; 15% of income
  • Food: $400 per month for the food; 20% of his income

Shelter “Needs and want”

Current: $800 per month on renting the condo in prime district area.

Proposed: Still near to office where he work, if he have rented one slightly further from the city, his rental may just cost him $500 per month.

  • $800 per month to $600 per month = $200 excess
  • This gives you $200 per month saving; 10% of monthly income

Transport “Needs and want”

Current: $500 per month on the latest Tesla Model Electric Car.

Proposed: Still getting a car for the convenience he wanted, if he have brought a car in good condition but not a luxurious car his car loan may just cost him $300 per month.

  • $500 per month to $300 per month = $200 excess
  • This gives you $200 per month saving; 10% of monthly income

Latte “Wants”

Current: $300 per month on Latte alone.

Proposed: Still having to enjoy his favorite drink, he drink 1 less latte a day, he would have saved $5 per day and $150 per month.

  • $300 per month to $150 per month = $150 excess
  • This gives you $150 per month saving; 7.5% of monthly income

Food “Needs”

Current: $400 per month on Food and it seems pretty reasonable

Proposed: No change is required.

  • $400 per month to $400 per month = $0 excess
  • No change

After calculating and listing down his expenses after the expense reduction John found that his total monthly expenses as follow:

  • John spend $600 (shelter) + $300 (transport) + $150 (latte) + $400 (food) = $1,550 per month

With a salary of $2,500 and take home cash of $2,000 after tax, john spent $1,550 per month and have $450 saved per month.

John have successfully allocated and budgeted his home budget to approximately:

  • 50% in Needs
  • 30% In Wants
  • 20% in Savings
Budgeting Plan Development

Step 4. Monitor your progress

Once you have your budget set in place. You can now finally relax and see your bank account increase from a 3-figure to 4-figure to even a 7 or 8-figure.

All great plans only remains great if you stick to it, thus you have to monitor and track your progress on a periodic basis.

Check your progress quarterly.

You can use budgeting apps, spreadsheets, bank apps etc. to aid in your journey in reaching your financial goals.

When choosing these budgeting apps, there are a few factors to consider.

  • Ease of use
  • Category range
  • Budgeting tips
  • Goal setting strategy
  • Security

I will personally choose to use a budgeting app developed by the bank. As money is consider sensitive information, I find it more comfortable to use apps developed by bank compared to third-party budgeting apps.

But if you decide to go with a third party app, make sure they have the following features.

SSL encryption

  • These SSL certificates ensure the contention is encrypted and keep you safe from hackers.

VeriSign

  • Provides firewall protection, and added security, who doesn’t love more security.

Multi-factor authentication

  • At least 2 level of security to ensure all your information are safe.

Step 5. Evaluate & Adjust Your Plan

Last step in creating a budget. Perform periodic review of your 50/30/20 Budgeting Plan.

This step will allows you to identify any outliers and gives you an opportunity to do any adjustment on the budget plan when it is required.

During your evaluation you can ask yourself these following questions:

  • Are you following the 50/30/20 budget plan?
  • When you are adding your monthly expenses, do you notice any unexpected big numbers.
  • Is there and increase in expenses for any of the category?
  • Did you spend more on food this month?
  • Did you get a pay raise and do you need to do some adjustment to your budget allocation?

It’s OK to have wants. But you should always set a limit on how much you can spend on your ‘want’.

If you are planning to go for a vacation by the end of the year, plan ahead and allocate a portion of your income in the “want” category for it.

On the other hand, if you need to ‘borrow’ money for that vacation, maybe it will be better idea to put it off till next year.

Getting yourself into bad debt due to consumer spending is never a good idea for your personal finance.

Most importantly:

Always stick to your plan! 

  • 50% on needs and should always keep it below 50%
  • 30% on wants and should never let it go over 30%
  • 20% on saving and should always aim to increase the amount for savings, because this is where the rich get richer and poor get poorer.

The secret to success is to increase your saving much higher than 20%. The more you save and invest the faster you can reach your goals.

Read Also: How much money do you need to retire comfortably?

A Wise man once said

“Future is built for the man or woman who is most prepared.”

What is Meant by Budgeting?

Budgeting is the process of creating a plan on the spending of your money. The spending plan is called budgeting. Creation of this plan will allow you to allocate your money into buckets, where you will plan in advance on where will your money be spent.

In the process of your planning, you will balance your expenses with your income.

During this part of your financial planning, you will assign your future personal income towards expenses, debt repayment and savings.

A home budget, or personal budget provides an easily understood breakdown of how much money coming in and how much is going out.

why budgeting is important in personal life?

Budgeting is important because it allow us to track our expense, and visualize our spending habits. More importantly, budgeting can help us make better financial decisions, get out of bad debt, prepare for emergencies, and keep us focus on our long-term financial goals. 

Relieve you from your financial stress.

When designing our budget, we will look into our past spending, as well as our current income. Using these numbers, we will be able to carefully plan ahead for on the budget.

Creating our own budget is essential for us to prepare for our future and answer questions such as:

  • Should we buy or rent a home?
  • Should we get that new car I am dying for?
  • Should we get the latest smartphone or iPhone?
  • How can we better prepare our 6 year old kids who is going to school next year?
  • Where should we plan for our next vacation? Should we go to some nearby towns, or a luxurious trip to Hawaii?

A good budgeting strategy allows us to plan for the nice thing that we always wanted without us going into debt and break our bank.

Conclusion

The 5 Steps to creating your own 50/30/20 budget is simple, but having the discipline is the most important of all.

  1. Define Your Goals
  2. Know Your Income and Expenses
  3. Developing Your 50/30/20 plan
  4. Monitor Your Progress
  5. Evaluate and Adjust Your Plan

These 5 steps are the keys to financial success and a lifetime of riches.

Question is:

Are you up to the challenge to create your Home Budget and stick to it!

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Disclaimer: I am not your financial adviser or lawyer, information found in our website are just my opinions. You should always ask your financial adviser or lawyer for any financial or law related advice.

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