One of the most popular budgeting strategies is the 50-30-20 budget, which recommends that people spend 50 percent of their money on necessities, 30 percent on discretionary items, and 20 percent on savings.
I’d propose an alternate plan: the 80/20 budget. Here’s how it works:
First, some background: the 50-30-20 budget was proposed by Harvard economist Elizabeth Warren and her daughter, Amelia Warren Tyagi.
The duo says you should base your budget on your “take home” income -- your income after taxes, health insurance premiums and other expenses are taken out of your paycheck.
Half your take-home income should go toward necessities like housing, electricity, gasoline, groceries and the water bill, they said. Another 30 percent can go to discretionary items like restaurant dining, buying a new cell phone, drinking beer or getting tickets to a sports game. And 20 percent should go towards savings or paying down debt.
Two Concerns with the 50-30-20 Budget
Now, I’d like to say -- for the record -- that I believe this is absolutely sound advice. But there are two aspects that concern me.
First, it can be tough to discern what's a want and what's a need. Home internet is a need if you conduct business from home, but a want if you don't. Clothing, up to a certain point, is a need, but after that point, more clothing becomes a want. Bread and milk are needs, but ice cream is a want. How far will you take this? Are you going to line-item your grocery bill to separate Oreo cookies from spinach?
And that question leads to my second concern: some people don’t want to classify and track their spending.
In order to know how much money you’ve spent on groceries, utilities, concerts and iPads, you need to track your spending. That’s not always a deal-breaker -- some people enjoy tracking their expenses in Quicken or using online tools like Mint.com -- but many people just have no desire to track their money. “Budgeting” sounds like an excruciating word.
The 80/20 Plan
So what money-management substitute would I recommend for those people? I’d like to propose a close alternative: the 80/20 budget.
Under this budget, you put 20 percent towards savings and spend the other 80 percent on everything else.
The beauty of this plan is that you don’t have to do ANY expense-tracking. You simply take your savings off the top, and then spend the rest.
How would this play out in real life? I’d recommend that you set up an automatic withdrawal from your checking account to your savings account. Make sure this withdrawal happens every payday (or maybe 1-2 days after payday, in case your paycheck is delayed).
This way, the money that hits your checking account is yours to spend. The rest of the money is stashed away in savings.
Of course, keeping money in the same savings account that’s linked to your checking account can be tempting. It’s easy to transfer that money back into your checking account and then spend it. So I’d recommend withdrawing the money to a savings account that’s at a different bank. This way, you won’t see the balance when you log in to your account. Out of sight, out of mind.
(I particularly like SmartyPig, an online bank that allows you to create different “savings goals” and direct your money into each of these goals. You can read all about SmartyPig here. Just avoid the temptation to use the money to buy gift cards, which SmartyPig tries to push you into doing. That’s SmartyPig’s most negative aspect, in my opinion.)
Not all the savings has to go into a traditional savings account. You can redirect some of the money into a brokerage account, like Vanguard or Schwab, in which you’ve set up a retirement savings account such as a Roth IRA.
In fact, if you’re saving at an 80/20 rate, I would recommend that the vast majority of your savings money goes towards retirement. Experts advise saving between 10 to 20 percent of your income towards retirement, depending on the age at which you start to save.
(If you begin saving 10 percent of your income towards retirement at age 21, invest in an age-appropriate mix of stocks and bonds, rebalance annually, and adhere to making regular retirement contributions, you may be able to get away with saving only 10 percent of your income towards retirement. If you wait until your 30s or later, though, you may need to save 15 percent or more in order to have enough. Read more: How Much Should I Save for Retirement? and Retirement Savings By the Decade)
Don’t Stop at 20 Percent
One final note: I suggest 80/20 as the minimum that you should save. It’s always a great idea to save more. Once you achieve 80/20, can you push yourself towards a 70/30 savings rate? How about 60/40?
Remember: the more you save, the more flexibility and opportunity you’ll have. You’ll be able to build a larger retirement portfolio, retire a few years earlier, buy a rental property, start a small business, take a career risk or enjoy extra vacations.
Disclaimer: The information on this site is provided for discussion purposes only, and should not be misconstrued as investing advice and/or professional financial advice. Always consult with a licensed financial professional.