You know how much money is coming in. You know how much money is going out. So, how do you work with this information to build yourself a budget for a promising financial future, whilst still being able to live the way you want to.
We all know that when it comes to saving, it’s most effective to have a budget.
How much should we be saving and how much should we be putting aside for the monthly ASOS splurge? And if not ASOS, then football tickets, or rounds in the pub, or the endless list of unnecessary (but entirely necessary) purchases that stack up month by month?
Harvard bankruptcy expert Elizabeth Warren - that’s the kind of title we can really listen to - come up with a spending and saving rule to live by. She believes that your monthly tax-free income is most effective when split into 50/30/20.
- 50% should go towards your needs.
- 30% should go towards your wants.
- 20% should be put into savings.
So how does the 50/30/20 plan work and will it work for you? Here's how Elizabeth Warren believes you can make the most of your budget.
What’s your after-tax income?
In order to figure out what you have to divide into these categories, you need to figure out exactly how much you’ll get on a monthly basis.
Your after-tax income is what remains of your paycheque after taxes and mandatory payments are taken out, such as income tax, national insurance, student loan repayments, and pensions.
Usually, these amounts will be taken out automatically before your wage is paid to you and you should be able to find the final amount on your payslip.
As an example, the UK national average wage is around £28,000. Based on HMRC tax rates, this would give you £22,428 yearly after tax with £3230 going towards tax and £2349 going towards National Insurance. If you’re earning £28,000, you’re likely to receive around £1868 monthly after tax. And now you’ll split that 50/30/20.
What Are Your Financial Needs?
The largest portion of your income should go on all the important bits.
Rent, bills, the weekly food shop, and any medical expenses should all be covered in your ‘needs’.
You should also cover making the minimum debt repayment in this amount as these are crucial payments, which if missed could cause further charges or damage your credit score.
So, if you’re earning £28,0000 per year, you would have approximately £934 to spend on rent, utility bills and debts a month.
The difference between wants and needs is subtle but important. Needs are payments which if missed could have a severe impact on your quality of life. Wants are payments which if missed would be a minor inconvenience.
Focusing on the ‘needs’ will benefit your long term financial wellbeing.
What Are Your Financial Wants?
On paper, this sounds great! 30% of your monthly income to be spent entirely on having fun. But it’s not so simple.
This portion includes socialising, the gym, your haircut, your phone bill, the Netflix bill if you’re not lucky enough to be a streaming parasite on someone else’s account.
It adds up quickly.
Back to the £28K example, you’d have around £560 to spend on your ‘wants’. It can be really easy to blitz through this number - so it’s still incredibly important to be conscious and even frugal with your financial wants.
How Much Should You Save?
How you use this portion of your after-tax income depends entirely on your financial goals.
Depending on your situation, you may be looking to pay off your credit card or pay off a high-interest personal loan. Or perhaps you want to invest these savings with P2P for a high return rate and earn money via a passive income.
It’s entirely down to your personal situation.
If you’re earning £28K, you’d have about £373 left. According to Warren, this amount should go towards building a better financial situation for yourself. Whether it goes towards paying off your debts or investing your savings, it’s about working towards financial freedom.
Will The 50/30/20 Rule Work For Me? Key Takeaways
- 50/30/20 is a budgeting strategy created by a Harvard Bankruptcy expert to balance the way you spend your after-tax income.
- 50% of your income should go towards your ‘needs’ such as rent, utility bills, medical expenses and making minimum payments towards your credit card.
- 30% of your income should go towards your wants, such as your Netflix bill, the gym, shopping, haircuts etc.
- 20% of your income should either go towards paying off your debts, put away into savings, or invested in alternative finances like P2P to help you earn more money.