By Myles Leva
Last Updated: December 30, 2021
The need for a new budget can arise from many different causes.
Recent graduates and those who just made a major financial decision (ie. purchasing a new home) are normally faced with a new financial landscape. When you’re introduced to a new financial reality, grounding yourself with a realistic budget can help you start off on the right foot.
No two people are in the exact same financial situation. Specific needs necessitate different levels of minimal spending. That’s why budget ratios are a good idea; they set universal budget percentages that can be broken down further according to your highly specific needs.
Budget ratios serve as simplified guidelines for setting a budget.
Budget ratios are unevenly split 3-factor ratios that include:
Each of these categories will then be broken down into several others. Needs, for example, can be broken down into food, shelter (rent or mortgage payments), and so forth. Savings can also be broken down into subcategories such as:
So, regardless of your individual needs and goals, the overall budget ratio is used to enable people to start saving in the simplest way possible. Instead of worrying about minor details and subcategories of spending, you first simply split your income into 3 categories.
The other way that budget ratios vary is by the particular ratio you use. The first ratio, 50/30/20 is more often referred to in literature and online. But there are other variations we will have a look at as well.
The traditional budget ratio is the first one we will look at. It has long served as a good goal, but of course factors such as varying incomes and the rising cost of living ensure it can’t be universally possible.
This ratio was first mentioned and popularized in US Senator Elizabeth Warren’s 2005 book titled “All Your Worth: The Ultimate Lifetime Money Plan”. The book set the standard of:
The first category covers all the essentials. They are the things you simply cannot opt out of paying for. Shelter, food, medicine/insurance, and other costs that are obligatory fall into the first category. It’s the category that is the most important to be honest about. Acceptable expenses that qualify for the needs category will normally include:
The “wants” category includes absolutely all spending that is not entirely necessary, excluding savings. This includes eating out, entertainment, and even clothing that costs anything above the absolute minimal expense. It’s important to stay strict about the difference between wants and needs. For example, gym memberships are also "wants" if working out at home or at the park is an option. This category is naturally the most diverse and includes:
The last category, savings, is more self-explanatory. It can include emergency savings, retirement funds, and other important long-term financial goals. It should be noted that in the original ratio, debt repayments should fall into the 20% savings category.
If you make a higher than average income and currently have a comfortably furnished home and functional vehicle, this is a good budget ratio to aim for. However, for many people, it’s not a realistic goal. Most variations of Senator Warren’s original ratio are based on the unfortunate realities of debt, high property and rent costs, and overall higher living expenses.
If you’re young and healthy, the need to save shouldn’t be as pressing as it would be for someone halfway to the official retirement age. Young people are often less financially established and stable due to:
It’s natural to lack the ideal financial circumstances. Even if you’re older, life’s circumstances may dictate that a greater share of your income must be dedicated towards essentials.
With this ratio, you will be saving less so you have more money to spend on essentials.
As another alternative, this often more-realistic budget ratio accounts for high costs of living during an era of slow wage growth. Many people, especially those living in big cities, can refer to this ratio to make up for sky-high rent costs.
Choosing a budget ratio is easy. That’s the whole point of them, they offer a psychological cushion enabling you to confront the reality of personal finance. However, there are a few steps that everyone should take to make budgeting easier and more realistic.
If you aren’t sure which choice is realistic, you can take inventory of your recent financial activity. Check your bank statements and receipts. What is your current budget ratio?
The thing with budget ratios is that you are using one right now without realizing it. If you don’t have an active budget ratio, your ratio is probably shifting month by month. But by getting a rough idea of where your money is going now, you can set more realistic expectations for your future budget.
Sometimes, it’s hard to know where you stand financially. Before using a budget ratio, it might make more sense to start tracking your natural spending habits for a month or two.
Expense trackers are more accessible than ever before. Many budget apps are meant for you to record expenses and build a detailed picture of your spending. Most of these same apps also have features for goal-setting and improvement over time. What’s even better is that many of these apps are (at least partially) free.
Personal finance can be incredibly difficult. On top of that, life tends to throw unexpected expenses at us all. However, budget ratios can be used to ground your financial habits and provide a framework for saving and improving your personal habits.
Life should be enjoyable, which is why most budget ratios take into account the “need” for spending on wants. This structure is meant to offer you a process for having your cake and eating it too.
March 30, 2023