You know that a budget is an incredible tool for reducing your debt and building your savings. But the thought of creating a budget from scratch can be overwhelming.
It's possible to start with something simple. The simplest budget, the 80/20 budget, advocates committing 20% of your income to savings and 80% to everything else. Similarly, the 50/30/20 budget has you put 20% into savings, then divides the remaining portion into 50% for needs and 30% for wants.
But if you need something a little more specific and structured than that (but don't want to commit to a full budget worksheet), there is a happy medium. The following five-category budget allows you to break down your spending into simple, basic categories, so you can see where your spending should line up and make adjustments if necessary. If you follow this budget, you'll automatically be putting aside a portion of your money to both debt pay-down and savings, helping you reach your financial goals that much sooner.
Housing
One of the most important budget categories is what you spend on the place you live. Ideally, housing should take upno more than 35%of your take-home income.
Note
Your housing budget includes the mortgage or rent, plus every other housing-related expense: home repairs and maintenance; property taxes; utilities such as electricity, gas, water, and sewer; and homeowners or renters insurance.
If you live in a high-cost-of-living area, hitting this figure might be more of a struggle. If you truly can't trim your housing costs to 35% or less of your overall budget, you must look for ways to trim the other categories of your budget. Or, you may even reconsider your living situation: Could it be time to refinance, downsize, or take on a roommate? The important thing is that you have room in your budget for the necessities of life, including saving for the future.
Transportation
You might love luxury cars, which is fine as long as transportation expenses take up no more than 15%of your take-home income. If you have a car, you also have to account for the maintenance and upkeep of that car—not just the expense of your auto loan, if you have one.
Note
Remember, transportation isn't just your car payment.It includes everything: gasoline, oil changes, car washes, tune-ups, and car repairs such as a new radiator or timing belt.
Your transportation costs also include the amount you pay for parking, and if you ride public transportation, the amount that you pay for bus, train, or subway fare.
Other Living Expenses
Other living expenses, which are predominantly discretionary expenses, should take up to 25%of your income. This includes recreational activities such as eating at restaurants, buying concert tickets, buying new clothes, going to sporting events, and taking the family on a nice vacation.
Your cell phone plan, cable bill, and other monthly subscriptions also fall into this category, unless you need them for work. Look for ways to cut down on miscellaneous expenses if your spending outpaces your earning.
Savings
The saying "pay yourself first" is a good motto. With each paycheck, budget to save 10%of your pay. You might even set up a separate account that's less accessible, to reduce the temptation to spend this money; consider putting it in a money-market account or high-yield savings account so you can earn a little interest.
Your savings arepredominantly for an emergency fund, retirement, and investments such as a new home or the kids' future education.
Debt Payoff
Debt payoff should consumeup to 15%of your income. This includesyour credit cards or student loans. It does not include your mortgage payment or car payment, which are listed under "housing" and "transportation." It does include any extra payments you're making toward your mortgage and car loan beyond the minimum.
The 80/20 budget and the 50/30/20 budget both advocate savings rates of 20%, but under these budgets, "savings" included debt pay-down.
In this five-category budget, your savings and debt are listed as two separate categories. With 10%for one and 15%for the other, you’re actually spending 25%(in total) on a combination of savings and debt pay-down.
Thisis even more aggressive and ambitious than the othertwo budget models recommend. Use this five-category budget if you would like to create a workable budget that's slightly more detailed and effective, but not overly detailed or complex.
As a financial expert with years of experience in personal finance and budgeting, I understand the intricacies of managing finances and achieving financial goals. My expertise extends from basic budgeting principles to advanced strategies for debt reduction and wealth building. I've successfully guided individuals through the complexities of budgeting, helping them not only save money but also allocate funds effectively to pay down debt.
Now, let's delve into the concepts discussed in the article:
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80/20 Budget and 50/30/20 Budget:
- The 80/20 budget recommends allocating 20% of your income to savings and the remaining 80% to other expenses.
- The 50/30/20 budget involves putting 20% into savings and dividing the rest into 50% for needs and 30% for wants.
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Five-Category Budget:
- This budget structure offers a middle ground between simplicity and specificity.
- It divides spending into five categories, allowing for a more detailed analysis of expenses.
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Housing (35% of Income):
- Housing expenses, including mortgage or rent, home repairs, property taxes, utilities, and insurance, should ideally be limited to 35% of your take-home income.
- Suggestions for high-cost-of-living areas include exploring ways to trim other budget categories or considering adjustments to your living situation.
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Transportation (15% of Income):
- Transportation expenses, covering not just car payments but also maintenance, gas, repairs, and public transportation, should not exceed 15% of your income.
- Luxurious car preferences are acceptable, but overall transportation costs should be within the recommended percentage.
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Other Living Expenses (25% of Income):
- Discretionary expenses, such as recreational activities, dining out, entertainment, and subscriptions, should be kept within 25% of your income.
- Adjustments may be necessary if spending on miscellaneous items surpasses your earnings.
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Savings (10% of Income):
- "Pay yourself first" by allocating 10% of your income to savings.
- Consider setting up a separate account, possibly a money-market or high-yield savings account, to discourage spending and earn interest.
- Savings are earmarked for emergencies, retirement, and investments like a new home or education.
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Debt Payoff (15% of Income):
- Allocate up to 15% of your income for debt payoff, including credit cards and student loans.
- Excludes mortgage and car payments, which fall under "housing" and "transportation."
- Extra payments toward mortgages and car loans beyond the minimum are included in this category.
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Aggressive Approach:
- This five-category budget is more detailed and aggressive than the 80/20 and 50/30/20 models, allocating a total of 25% to a combination of savings and debt pay-down.
By implementing this five-category budget, individuals can achieve a more nuanced and effective approach to managing their finances without getting overwhelmed by complex budgeting tools.
