Personal Finance: the Rule of Thumb for Budgeting
You don’t have to see the whole staircase. Just take the first step.
– Martin Luther King, Jr.
With most things in life, all you have to do is start. The same goes for budgeting. Even in the absence of financial goals or elaborate plans, you can still make considerable economic achievements through smart budgeting decisions. All you have to do is apply one rule of thumb or another.
What exactly is a rule of thumb? In English, that's how you call a practical guide that's easy to learn and apply in everyday situations. It doesn't offer exact solutions but can help you navigate new or complex problems. A financial rule of thumb allows beginners and experienced financial experts to achieve their money goals. As part of our series on personal finance for beginners, we highlight three rules of thumb on budgeting:
Rule 1: 50/30/20
Rule 2: 80/20
Rule 3: 70/20/10
Benefits of budgeting
A budget is a financial plan that helps you allocate funds to different categories of your life. You get to decide how much you spend, save or invest based on your take-home income (the amount that's left after paying for taxes and medical insurance).
According to Spendmenot, only 32% of US families maintain a household budget. Why should you join them? Well, budgeting allows you to:
- Identify bad spending habits
- Prepare for emergencies
- Spend what you can afford
- Stay focused on your personal finance goals
Budgeting: the rules of thumb
As explained earlier, there is more than one rule of thumb when it comes to budgeting. These rules are not set on stone, either – in fact, they are used as guidelines and can be changed to fit your circumstances and income.
Rule 1: 50/30/20
This rule of thumb aims to make budgetary allocations easier. It was introduced in the book Your Worth: The Ultimate Lifetime Money Plan by Elizabeth Warren and her daughter Amelia Warren.
The Warrens proposed to divide all the take-home income into three segments:
- 50% for necessities: this includes electric bills, rent, groceries, and any other items or services you need daily.
- 30% for wants: this includes things like eating out or expensive trips. Anything you could do without, but decide not to because it helps you enjoy life to the fullest.
- 20% for savings. Spendmenot states that ~58% of Americans have under $1,000 in their savings. This portion of your income could be invested or put into a retirement fund. Consider putting it in a 401K or simply adding it to your emergency fund.
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Rule 2: 80/20
This rule of thumb is basically a more flexible derivative of the 50/30/20 rule. Just like its predecessor, it pushes you to put yourself first. This rule proposes that:
- 80% of your take-home income should cover your living expenses
- 20% goes into your savings or investment accounts
Summing the needs and the wants into one makes this rule a lot less complicated and easier to use. Plus, you do not have to feel guilty about including your wants or spend ours contemplating whether something you're about to buy counts as a need (haven't we all had these arguments with ourselves?).
To ensure you keep up with your savings, consider initiating an automatic withdrawal from your checking account. It can take place a day or two after you receive your salary. Additionally, you can use apps to make money. Honeygain is a great side hustle up that can help you build your savings over time.
Rule 3: 70/20/10
This rule of thumb is different from the rest. Unlike the previous versions, it focuses on repaying your debts. If you have any student loans, credit card debts, or mortgages to pay off, this is the best rule for you.
Your income should be divided as follows:
- 70% for your daily expenses
- 20% for your savings and investments
- 10% for direct debt repayments
Here are some of the reasons why debt repayment is essential:
- Accumulated debt increases the amount of interest you pay in the long run
- Missing debt repayments lowers your credit score
- Unchecked debt can plunge you into the debt cycle, making it difficult to attain financial freedom
Also, when you have less money to spend for your daily expenses, you tend to prioritize your needs over your wants, forming better financial habits over time.
How do you enhance your budgeting skills?
Depending on which rule of thumb you decide to use, below are a few tips to help you out:
- Have a clear idea of what your monthly income is. Include all the revenue from your job, as well as any smart passive income from Honeygain or other similar sources.
- Allocate a limit for each category. Put cash aside for your needs, wants, and financial goals without leaving any out. Some find it easier to use an envelope system, where each envelope respresents a separate area of expense, and you divide physical cash between them.
- Stick to your budget. Track your spending to ensure you are staying within budget over the course of the month. If not, include measures to help you save money and manage your expenses.
The pitfalls
Using a rule of thumb to improve your financial habits can be helpful. However, each of the practices shared today may have a few shortcomings:
- 20% may not be enough for your saving. This depends on your financial goals: if you plan to achieve a high target over a short period, you need to adjust your saving percentages accordingly. You can also make extra money and send it directly into your savings account. An easy way to do this is by downloading the Honeygain app and earning free money.
- Grey areas. Some items tend to fall under two categories. Food is a need. However, expensive food or treats could be considered a want.
- If your income is low, it may just be enough to cover your expenses. If this case applies to you, then consider becoming a Honeygainer and getting smart passive income effortlessly. Remember, the higher your income, the easier it is to budget and save. Honeygain allows you to make free money just by sharing your Internet connection. It is a safe and secure way to increase your take-home income and meet your goals.
- It still requires you to track your spending. Allocate a budget to each category is not enough – you still need to follow it by tracking your spending and keeping your expenses on track.
Choosing and following a rule of thumb in budgeting is an easy way to make smart personal finance decisions. However, the key to financial freedom lies in generating enough income to cater to your necessities, wants, savings and debts. Achieve this by earning smart passive income with Honeygain!
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