Are you looking for a simple and easy budgeting rule to live by? The 50/30/20 Rule of Budgeting is exactly what you’re looking for!
Have you ever wondered how much money you should be spending on certain things? How much money you should be saving?
Chances are you’ve spent the last while creating a budget. That’s awesome!
You’ve tracked your spending, divided your expenses and now, you know exactly how much you’re spending on your home, car, groceries and other important areas of your life. And that is amazing.
But, have you thought about your savings? Do you set aside money every month to use in case of an emergency or to put towards your retirement? How much should you be setting aside every month (in an ideal world anyway).
Numbers get thrown around all the time, you shouldn’t spend more than x on your rent. A car should cost y. You can afford a mortgage z times your salary. It’s frustrating and scary how much those numbers change depending on the source.
Luckily, there is a book called All Your Worth: The Ultimate Lifetime Money Plan. While I highly recommend the book, it was published in 2005 so some of the information is clearly dated.
Nonetheless, the 50/30/20 formula they give us for organizing our budget is timeless and answers all the questions I just asked.
50% Needs 30% Wants and 20% Savings
How do I use the 50/30/20 Rule of Budgeting
Step One: Find Your After-Tax Income
You know when you’re looking at your paycheck and wondering why the number is so much higher than what was actually deposited in your bank account?
We’re going to ignore the money you never actually have today and just focus on the money that actually makes its way to your wallet.
You’re going to want to pull out a pay stub for this because you want to know how much money you have after taxes. However, if your employer automatically deducts things like health insurance, retirement contributions, and any other deductions you can add them back to your total income.
This part is easy if your pay is generally the same. However, if your self employed, work variable hours, for a commission or anything else, you’re going to be a bit more work.
Remember self employed people have to remit their own taxes, which means you’re responsible for finding your after tax income.
If your hours change from week to week or you work for commission, just do your best to estimate and tweak your spending as necessary every month.
Step Two: Direct 50% of your after tax income to Needs
Take a look at your budget, particularly the expense column. Decide which of those expenses are “needs” and which are “wants.”
Needs are necessary expenses, the things you have to pay for because you can’t live and safe and healthy life without them. Things like groceries, rent/ mortgage, insurance, and bill payments.
When we’re following the 50/30/20 rule, no more than 50% of net income should be spent on needs.
If the number isn’t really meshing, than you have to be a bit more discerning with regards to your “needs.” The things you could forgo with minimal inconvenience are “wants” – think new clothing or your cable bill.
You may not be super comfortable if you forego those things but the inconvenience will be minimal.
On the other side, “needs” will severely and negatively impact the quality of your life and your ability to live in a safe and healthy manner. Rent is a need, as are prescription medications.
As far as credit cards and their repayment is concerned, the minimum payment is considered a need as not paying it can have a negative effect on your credit card bill. However, anything over the minimum is not a necessary expense.
Step Three:Cut your “Wants” down to 30 Percent
I know what you’re thinking but this isn’t as nice as it sounds. 30% of your take home pay dedicated to wants makes it look as though you’ll have loads of fun money, right?
I’ll admit when I first heard that number I had visions of vacations, expensive shoes and regular spa days. If only that was the case…
You’ll recall the things we considered needs are literally that. They the necessities of life. Wants are anything above that.
Wants are conveniences, those things that make our life easier and more enjoyable. Think high speed internet, Amazon Prime and your gym membership.
These things are everyday conveniences that we tend to take for granted. While we may find ourselves mighty bored without them, they aren’t necessary.
Chances are you have more “wants” than you might expect. I know I was surprised when I sat down and went through these steps for myself.
Obviously some things like shoes are essential. However, they are only a need in so far as you need shoes. The color, style and designer are a want as is buying them at full price from a mall, or a particular designer, instead of from a discount store is a want.
There certainly is a lot of gray area and wiggle room in these rules. But if you stick with them and apply them in a way that makes sense to you, I’m sure you’ll be embracing it in no time.
Step Four: Direct 20 Percent to Savings and Debt Repayments
To recap quickly we have 50% of our take home income going to needs and 30% going to wants. If I’m doing the math correctly leave us with 20% to do something with.
We’re going to use this 20% to save and pay off debts. This is where you can account for any extra money you like to put toward your credit card bill, any money you put away for retirement or your emergency fund.
The minimum payments for any debts or loans such as a mortgage, car loan or credit card count as a need, any payments beyond that belong in this 20% category.
This is the one area of our financial plan where you don’t need a good reason to go over. If you can afford to save more than 20% of your income to paying off debts or saving, please do so.
50/30/20 Rule of Budgeting in Practice
Let’s look at a practical example.
Net Pay – $3000/ month
Needs (50%) – $1500/ month
This is also a great way to show how much we can afford if we’re looking to purchase a house or an apartment. With $1500 to cover all our needs, we probably can’t afford a $1200 rent payment.
This is especially true if our rent doesn’t include free cable, internet and utilities. Not to mention car payments, minimum debt payments and insurance premiums. There is also that awkward part of us that buys groceries and would like to eat relatively healthy food during the month.
There’s is a lot to cram into that 50% and it would be very easy to go over if we’re not careful.
Obviously there are situations where we go over our allotted 50% and there is little to nothing we can do about it. For example someone may have a mortgage they can’t or don’t want to get out of, or even signed a lease for an apartment.
The key is awareness and doing the best with the opportunities and barriers we have in front of us.
Wants (30%) – $900/ month
This is where we can find money for things like Netflix and high speed (as opposed to basic) internet. We can also supplement the cost of organic food if we so choose.
Aside from furthering our basic needs, this is also the place to account for the costs of entertainment, dates, updated home furnishings and even holiday presents.
If we’re not careful this area of our budget can quickly balloon to a much higher number than we can comfortably manage.
After taking a close look at your budget, if necessary and possible you may want to shift some of this money to your needs at least until you can get them more under control.
Savings/ Debt Repayment – $600/ month
You know what you have to do with this money. Start paying down your debt, building your emergency fund, planning for your future. The important part here is that we’re disciplined enough to put the money away and not use it to cover those other expenses.
can get your needs down to a more manageable level. Remember, you still need 20 percent left over so you can save and pay down your debts according to the 50/30/20 plan.
Some Awesome and Easy Ways to Save Money
How do you feel about this method for budgeting? Does it sound doable or are the numbers just too far off to work in your situation?
If you’ve tried this please let me know how it went. Are you still following this rule in your budgeting practice?