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Guest Post: Budgeting - 50/30/20

The following was written by Jeremy Neuman from financeforjerrys.com

Do you know how much money you spent last month? If you didn’t raise your hand, you’re one of the 65% of Americans who struggle to properly budget.

Creating a monthly budget is the cornerstone of personal finance since it allows you to:

  1. 🕵️ Figure out where your money is currently being spent
  2. 💡 Identify where you can make changes to improve your financial health
  3. 📈 See the impact of spending or income changes on your financial goals

Budgeting can seem daunting to start since it brings up feelings of confusion on where to start, stress over tracking receipts, and guilt about not sticking to it after all that.

Instead of comparing several of the popular methods (zero sum budgeting, envelope system, pay yourself first) I’m just going to focus on my personal favorite, the “50/30/20 budget.” I’ve stuck to this one for 7 years now because it comes with built in guard rails and is the simplest to keep track of. I’ll give a quick overview in this blog post, then walk you through how I got started with mine after graduating college.

The 50/30/20 rule divides your budget into three categories and has a recommended ratio for each (based on after-tax income):

  1. Fixed costs - 50%
  2. Discretionary spending - 30%
  3. Savings - 20%

These are just helpful guidelines to create a starting point for a “reasonable budget”, but spoiler alert, my fixed costs were over 70% in my first post-college budget🙃.

There are three keys to why this budget works well:

  1. You can determine your discretionary spending by first determining the other two categories
  2. You can simplify managing your discretionary spending by reducing it to a “magic number”
  3. You can make it easier to stick to the budget by automating payment of your fixed costs & savings (we’ll get into automation & cash flow management in a later post)

The simple formula is: Discretionary spending = (Income - Taxes) - (Fixed costs) - (Savings)

Fixed Costs - 50% This is the boring stuff you need to survive on a monthly basis / not have loan sharks break your kneecaps:

Most people will leave this category after those big ones but I advise my friends to be overly specific in this section. If there are things you know you’ll be paying for on a monthly basis, put them here so they’re front and center. Once these are identified, you can figure out where there’s fat to trim, but the key benefit of allocating them upfront is it drastically simplifies your life downstream. Some obvious and non-obvious examples:

Savings - 20% While this category comes last in 50/30/20 I prefer to keep it second to avoid the common mistake of spending first then figuring out what you can save last. Remember the formula from above!

We’ll get into where you can put your savings in later blog posts (cash, 401k, IRA, HSA, etc.) and I’ll note the 20% is aspirational for most people early in their personal finance journey, but just know that the more saving the better.

Discretionary Spending - 30% Now that you’ve determined how much of your paycheck will be vacuumed out of your bank account monthly & how much you can squirrel away, you’re left with the fun money 🍾

So if you made $100,000 (post-tax):

Now you may think the next step is to budget for every other thing you’d spend on a monthly basis (drinks, tickets to events, ubers, flights, etc.) but you’ll be happy to know you’re wrong! The beauty of putting this category last is you don’t need to track where the money goes since it’s up to your discretion what you spend it on. I’ve found discretionary spending is highly variable each month since what you do for fun changes frequently so trying to line item everything in this bucket is more trouble than it’s worth.

To make this category actually useful though, you can simply get to what I call your “magic number” by converting it to weeks: $30,000/year → $2500/month → $625/week

Voila, since each month you’ve already factored in what you’ll be auto-paying for fixed costs and putting aside for savings, now you can just keep tabs on whether you’re crossing that $625 line each week. If you do cross it? No worries, aim for a bit less next week. If you undershoot it? Congrats, treat yourself next week with the remainder or start putting those remainders aside to save up for something nice.

We’ll put this budget into practice in the next post, using my own example.