When you follow a budget you avoid going into debt. That’s what everyone wants, right? We avoid debt, get a good credit score, invest and grow rich, and have a wonderful life in the meantime. Yet, according to the Canadian Financial Capability Survey, one in six Canadians, or 17% of the adult population, spends more than they earn and would benefit from a budget.
So, why don’t we stick to budgets? The simple answer is that you don’t implement the 50/20/30 rule when making the budget. You need to plan where your money goes, track it, and also build-in fun. Yes, fun is a requirement for making and sticking to a budget.
You can stay motivated and enjoy yourself without compromising your future. Carefully calculate your expenses and the savings show up. This helps to avoid unexpected events, such as a car crash or the replacement of a computer. Get ready to (re)take the reins of your financial future with the 50/20/30 rule.
The 50/20/30 Budget Rule
Why this order, 50/20/30? It is a hierarchy of the categories of expenditure to which a percentage is attributed: essentials, savings and pleasure. Yes! 30% goes to pleasure! Wait, keep reading.
The 50/20/30 budgeting method exploded in popularity since American Senator Elizabeth Warren introduced it in her book All Your Worth: the Ultimate Lifetime Money Plan, published in 2006. The 50/20/30 rule divides your income into three categories. The numbers 50/20 and 30 are actually percentages of your net income. 50% is allocated to your basic needs, 20% to your savings and debt repayment, while 30% is reserved for pleasure. Let’s explain them, in that order.
Budget 50% of your income to essentials
What can’t you live without? Food, certainly, and a roof over your head. In this category, we include the things you absolutely need:
- Basic clothing
- Insurance: home, car, and health insurance in some cases
- Health care not covered by provincial insurance
For those who don’t like numbers, this method is great. For example, let’s take a monthly net income of $3,000. How much do you have to allocate to essential expenses? A maximum of $1,500, or half of the net total.
What are some tips to avoid going over this 50% limit when you don't have to? Learn how to cook more and buy products at a discount. Some meats are less expensive than others and homemade snacks are cheaper than those you buy at the grocery store. Also try to get out of the car, if you have one, and onto public transit. A car ends up being very expensive when you consider gasoline, maintenance, and repairs.
Also, review your insurance policies every year and shop for new ones. Use a life insurance policy comparison tool or compare prices online or on the phone. Providers know that you get complacent and increase their prices over time. There are often promotions that you can take advantage of by changing to a competitor. Also analyze your housing needs, the size and location of which can have an impact on heating costs and the need to have a car. If you’re a homeowner, compare your mortgage rate to your competitors. It may be time to refinance your mortgage at a lower rate.
Budget 20% to debt repayment, savings and investment
Are you one of the 1 in 6 Canadians who spends more than they earn? If you don’t know the answer, take the time to do the math. Spending recklessly can quickly lead to a spiral of debt. If you are unable to repay more than the minimum payment on your credit card, let’s hope that the 50/20/30 rule helps you increase the amount allocated to this category. That said, 20% of your net income should go to:
- Debt repayment
Paying down expensive debt is a priority. It's very important to pay down high-interest credit cards debt. A car loan with 0.1% interest is a lot less pressing. You also have to start an emergency fund. The idea is to set aside, in a separate but easily accessible account, the money you need to live for 3 to 6 months. It will help you if you lose your job, for example, to stay out of debt during that period. Once your debts are paid off and your emergency fund is set up, consider saving and investing in investments that offer a return, for example for your retirement or for medium-term projects.
Are you worried about saving too much and not living life to the fullest? Personally, I am much more afraid of finding myself without a penny at 85 and leaving nothing to my child! But we’re not all made the same way. The 20% of a net monthly income of $3,000 is only $600. We will come back to that. Just so it's clear, you can adjust the percentages.
Budget 30% for fun
Finally, we get to fun! 30% of a net monthly income of $3,000 is $900. Unless you have very expensive hobbies, that should be enough. The 50/20/30 budgeting rule is not meant to suck up all the fun out of your life and that is one of the reasons why people can stick with it. Once essential expenses and savings are covered, you can spend 30% of your income on:
- Dining out/take out
- Alcohol: this is not part of the grocery category
What’s the point of saving for the future if you don’t enjoy your daily life? It is not recommended that you sacrifice your life and health to save money. Fun is great for mental health, and sometimes for physical health too. For example, exercise is good for the body and soul. Take yoga classes or join a soccer team.
Do you like to spend a week in an all-inclusive in the middle of winter? That’s fine, but budget for it and then book that flight. Netflix, Crave and your favorite apps will also bring you some fun on a daily basis.
But now that restaurants and concert halls are opening their doors again, you may be tempted to enhoy them often. Remember that these are a little more expensive than home entertainment. If you have enough money to pay your rent and save, there is no limit to how much you can spend to relax and have fun.
Why do we like the 50/20/30 budgeting rule?
The 50/20/30 is easy to follow and simple to remember. It has an easy structure that prioritizes necessities first and then savings; these must come before fun. You only have 3 categories of expenses to manage, dividing your net income according to the assigned percentages. There is nothing scary or complicated about setting up a 50/20/30 budget.
Furthermore, like any budget, it helps you think about your spending and priorities. For example, what is making you if you put more than 50% into your essential expenses? Did you buy a car that takes up a lot of money? Did the rent go up and you now need to get a roommate? Did your basics get more expensive?
We also like the flexibility of 50/20/30 budgets. You can change the percentages allocated to each category. For example, if you have a lot of debt to pay, reverse the 20 and 30. Or, if you find yourself temporarily unemployed, reduce your savings to focus on essential expenses.
However, this flexibility does not justify a permanent change where 80% of your income goes to essentials. If this is your situation, you should instead try to revise each expense and optimize it. Getting closer to the exact percentages 50/20/30 offers you the right balance in life. Yes, it is responsibility but with a side of fun.
Making a budget with the 50/20/30 rule, is it for you?
The 50/20/30 budget method, although flexible, is not for everyone. The distribution of percentages is hard when a person has a salary close to the poverty line, is over-indebted or lives in a city where housing is expensive. These situations require allocating more to the first two categories. Does your mortgage or rent alone take up 50% of your income? Will it take you a long time to get debt free with only 20% budgeted to repayment? If you spend your time changing the percentages of the 50/20/30, this method may not be the right one for you.
About The Author: Maude Gauthier
Passionate about finance, entrepreneurship and real estate, Maude has explored these three themes in hundreds of blog posts. Before moving into writing and marketing in 2018, she worked in university research for several years. Graduated, re-graduated, and over-graduated, don't be surprised to cruise into an online course or conference. Variety and diversity are her watchwords!
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