So far we have discussed about what a personal budget means, how that is helping you and how to use it.
Briefly, a personal budget is the tool that gives you an image as clear as possible of your expenses and your income, so that you can make some decisions in your financial life.
What king of decisions you can make with a personal budget:
- Increase you income – if your income is too low to support your basic expenses. It also helps you to diversify them.
- Decrease your expenses – if your expenses are larger than your income, which is a warning for you. In this case, you have to make numerous decisions helping you get into a financial balance.
- It helps you manage your money better. How? You will see that your money goes for certain categories of unproductive and inefficient expenses, such as: “bad” financial habits, going out, lots and often vacations, eating at restaurant/fast food.
These are only 3 (most important) of the reasons why you should use a personal budget.
What I want to show you in today’s article is a series of methods to plan the money in your personal budget. So, if you do not have a personal budget yet, not is the moment to get one (you can use a piece of paper, or an Excel, as I do, or a mobile app).
The planning model I want to show you below is one of the simplest, but useful, models of personal budget.
I want to show you below one of the most efficient methods of how to manage your money better – The 50/30/20 Rule.
The 50/30/20 Rule
50/30/20 comes from the percentages you must give to the 3 categories of large expenses in your life. It is also called the Needs/Wants/Savings rule.
The 3 categories of expenses are: essential expenses, expenses for a personal lifestyle, financial priorities.
The entire financial planning depends on our lifestyle. You have to take into consideration a minimum of financial needs in your life, a desired lifestyle, but, especially, you must have a long term way of thinking which helps you during the difficult moments of your life. There will always be difficult moments and for this you need to be prepared also from a financial point of view.
Regardless of age or events you are going through, this rule can help you realise how much you should spend each month and it will also show you the order in which you should plan your money distribution.
Now, let’s see how the percentages are distributed when we plan our budget:
1. 50% of the income is directed towards the essential expenses
The first expenses you should plan are those expenses mandatory for your survival. Those expenses you really need to keep your life healthy and free: housing, food, heat, transport etc.
Out of the categories of a personal budget, the expenses included in this area are the following:
Housing expenses: rent/bank instalment, house insurance, utilities;
Expenses for food and medication;
Expenses for transport: by car (if your income gives you this possibility) or by mass transportation;
Other debts, if the failure to pay them draws more expenses.
Be very careful about the percentage. If you have a large income, it will be easy to keep a car, if not, my advice is to use mass transportation to your job or to other places you need to get to.
2. 20% of the income is directed towards your financial priorities
The second step you need to follow is to set the 20% towards your financial priorities.
What does this mean? It means that 20% of your income will be directed either towards an emergency fund, or towards a savings account, or towards a retirement plan, or towards debts (those that are nor drawing penalties for you if you do not pay them on time – those are added at the first step), or towards an investment plan.
Simply said, these 20% are money saved for difficult days and to produce money. Money to produce more money.
You will definitely need money in your old age, or you want to open a business and to work on your own. This money is for those kinds of things.
You are saving in order to make it easier for you later.
Attention – This money will never go into the 3rd category of expenses, which I will show you below. They can be essential expenses only when you will no longer have an income and you have to support your living.
Remember – Always, this 20% you have to plan is step number 2. Never let your expenses for fun go in front of the expenses “for the future”.
3. 30% of the income is directed towards the expenses for a personal lifestyle
We have reached step number 3, step where you have to manage the remaining percentage out of the 100% of the expenses for a more pleasant lifestyle.
This is the money you give in order to raise up your life level. This is money directed towards various gadgets, internet and cable TV, parties, going out, vacations etc.
All these must not exceed 30% out of your total income.
It is a maximum threshold which you have to understand and apply.
I think that this is the most complicated category of expenses, because few can hold themselves back when it comes to personal fun.
According to a quite recent study made by 2 researchers, 70% of the people who used a personal budget and failed to manage it did so because of these expenses.
This happens because of the ignorance or the naivety by which we are treating these expenses. I am not saying we should not have fun or not go to bars or not take vacations. I am just saying that we should be moderate, so that we are not drawn into a trap of the personal finances.
The 50/30/20 Rule is one of the simplest and beneficial rules of personal finance we can use. We only need to juggle a little bit with the income and the expenses and to be smart when we take financial actions.
It is a rule applicable to anyone, regardless of age, but who must have a constant income each month.
It is a rule which could help lots of people manage better their own finances and to have a longer and more peaceful financial life.