50-20-30: Go on a diet for your money

Starting your first job after graduation this September? Struggling to manage the household budget? Well, you’ve no doubt heard about the Atkins diet, the 5x2 or “clean eating”, but how about something akin to a diet plan for your money?

It's never too early – or too late – to start budgeting properly. It's getting started that's the tricky bit. Given that we've had everything from the fast plan to the 5x2 for our diets, it's no surprise that someone has come up with a simple, catchy plan to help you plan for your future by keeping your finances in everyday shape. The 50-20-30.

How does it work?

The 50-20-30 plan is the inspiration of US senator and Harvard bankruptcy expert Elizabeth Warren. Together with her daughter, Amelia Warren Tyagi, she came up with the plan to help people manage their money.

As the name suggests, the 50-20-30 plan is about allocating a specific percentage of your money towards specific tasks.

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In this case, 50 per cent of your after-tax income should go on everyday spending, such as your rent or mortgage, phone bills and food.

Next up, 20 per cent, or one-fifth of your income, should go towards meeting longer financial goals. This can be everything from building up your savings, to starting to invest, to paying down credit card or student loans.

Finally, 30 per cent can go on what’s deemed to be “flexible spending” – ie stuff you don’t really need but like to buy or spend money on, such as clothes, concerts, travel, eating out etc.

Get started

The first step is to work out what your income actually is. While many of us know exactly how much goes into our accounts at the end of year month – largely of necessity – if you’re starting a new job, you won’t know exactly what that salary is going to translate into.

Thankfully, this is very easy to do. Big 4 accountancy firms such as KPMG and PwC typically offer budget calculators that allow you to work out your take-home monthly pay easily and quickly. Remember to include any benefits you're entitled to, such as children's allowance or the State pension, as well as any other income streams you may have.

And keep an eye on October's budget from Minister for Finance Paschal Donohoe, which may signal an uplift – albeit modest – to your after tax income.

Work out your ‘needs’

Now that you know how much money you’ll have each month, you can start deducting all those bills and essential spending from it. This means everything from rent, home insurance, childcare, school clothes, property tax, health insurance, car insurance, petrol, car loan, GP bills, electricity bills etc.

It may also include some items that others would consider to be “wants”. For example, if a gym membership or monthly hair cut is as essential to you as health insurance is to others, then it should go in this category.

Already, however, you’re probably going to find the budget a bit tricky to stick to.

Consider a family earning €80,000 a year. With just €2,136 to spend on “needs”, there may not be much left over for the electricity bill or the weekly shop when rent or a mortgage and childcare are factored in.

Start saving

If you don’t budget, typically whatever you have left over, you’ll save. The danger with this approach, of course, is that spending too much on your “wants” will leave you with too little to save.

A way to get around this is to follow the old adage of “paying yourself first” by setting up a direct debit so that the money you’re saving goes out of your account soon after you get paid. Yes, you may be dissuaded from doing so by the poor level of returns on offer, but at least your money will be building up regularly over time.

After all, if you’ve never had it to spend in the first place, you won’t miss it.

For example, the best return on a regular savings account at present is 3 per cent, on offer from EBS. Yes, you may only earn €20 or so in interest over the course of the year (and you’ll have to give up 39 per cent of this in Dirt tax), but if you set aside €100 a month you will still have a little nest egg worth more than €1,200 at the end of the year.

You could also consider taking a bit of a risk with your money. While some say stocks, particularly in the US, are overvalued, choosing wisely could boost your returns. And by saving on a monthly basis, you’ll be “averaging-in” to the market, which can help smooth those volatile bumps on the road.

If you could boost your returns to 6 per cent, you would have €1,233 after one year, and €2,543 after two.

If you’re in debt, you should also use this 20 per cent to pay over and above what is “essential” – ie the minimum repayments which would fall into the 50 per cent. This can end up saving you a lot in the long-term.

Consider a credit card debt of €5,000. If you keep to the minimum payment of €150 a month, it will take you four years to pay off, and cost you an extra €2,359 in interest – and that’s assuming you don’t add to that bill in the meantime. On the other hand, if you can boost those repayments to €300 a month, it will take you less than two years to repay, and will cost you less than €1,000 in interest.

Others very effectively take such an approach to reduce their mortgage debt. But if you don’t have the cushion of a rainy day fund, it may make more sense to build up a savings fund first.

Remember also that this 20 per cent should include pension savings. And as you earn tax relief on this, you may earn yourself a little reprieve which can be put back into your “wants” – or used to bump up your savings even more.

For example, a monthly contribution of €100 into your pension will only cost you €80, if you pay tax at the standard rate of 20 per cent, as tax relief accounts for the other €20. If your earnings are higher and you pay tax at the higher rate of 40 per cent, that €100 contribution will only cost you €60.

Limit your ‘wants’

Discretionary spending should be limited to 30 per cent of your take-home pay. This means someone on a salary of €30,000, for example, gets to spend about €632 a month on new clothes, eating out, holidays and general lifestyle spending, while someone earning €80,000 can spend about €1,281 a month.

This is the section where you can really squeeze your spending, as it should be discretionary. Swapping a meal out in favour of a few drinks out, or the cinema for a movie with friends at home, can help keep your spending down.

Are there weaknesses of the plan?

Undoubtedly, the 50-20-30 is not going to be for everyone. Putting away 20 per cent of your disposable income each month will be simply a step too far for too many of us, especially in our early years at work when we move out of home, or have young children – because we simply can’t afford it.

However, where plans like this have the most value, perhaps, is getting you to reconsider your spending. Maybe you’ll hit the magic 50-30-20 formula, or more likely you won’t. But if you can decrease your discretionary spending, to the benefit of either paying down debt or boosting your savings, it will really benefit your financial health.

And that’s something worth thinking about.

Tools to help you budget

Apple/Android pay If your bank offers either Apple or Android pay, you should consider using them to pay for your everyday expenses, as they allow you to easily track your spending.

Spending too much on coffee or pints? This app will quickly identify ways you can cut back on non-essential spending. Some of the newer mobile banking apps, such as that offered by N26, can also help.

Zurich budget calculator This calculator will help you work out what your monthly income and expenses are, what you need to budget for, and how much you have available to save. (http://iti.ms/2gZe4vD)

Mabs Budgeting Tool This tool allows you to set out your income and expenditure and make a budget. It takes roughly 15 to 20 minutes to work through the tool. It is time consuming but could help you take control of your spending again. (http://iti.ms/2vFpojQ)

Bank of Ireland Money Manager If you're a Bank of Ireland Banking365 customer, you can run its money manager tool from your online banking account. It gives you a breakdown of where you're spending your money – household, insurance, savings etc – and can help you plan for events down the line.