Sitting down and hashing out the details of your budget doesn’t have to be an onerous process, arguing with yourself over small price differences for toothpastes won’t make or break your budget and can make budgeting seem like you have to micromanage your spending habits.
The 50/30/20 budget rule makes assessing your monthly personal finances a walk in the park.
There is no one-size-fits-all, umbrella budget strategy that has right answers for everyone. We all have different lifestyles and value different things, whether you value a nice home over a sports car is up to you and you should budget for either appropriately.
The 50/30/20 budget rule is a simple heuristic that you can use to plan how you want to spend your money. The 50/30/20 rule says that you should spend 50% of your after-tax income on needs, 30% on your wants and the remaining 20% of your income should be stashed away into savings.
These proportional guidelines can help you keep your spending habits in line with your unique long-term goals and assure that you’re preparing for the future.
To start, determine what your after-tax income is for one month, you can do this by taking a look at your paychecks and adding them up to see how much cash you take home. If you have deductions from your paycheck that are taken out pre-tax like health insurance or 401k contributions, you can add these amounts back to your paycheck. Once you know your take-home pay you can start to see how your current expenses size up against the 50/30/20 rule.
Needs are just the essentials –
Your needs are expenses that you can’t live without. Dedicate a maximum of 50% of your after-tax income to expenses such as rent, utilities (electricity, gas), food, and transportation that are must haves. Netflix subscriptions, gym memberships, and fancy dinners out with friends don’t count and are considered a Want.
So if you’re monthly take-home pay is $4,000 you should allocate at most $2,000 a month for things like insurance, your cell phone bill, or groceries. If you end up only spending $1,500 in one month for your Needs, don’t take that extra $500 and spend it frivolously. Use that leftover money to budget for future expenses that don’t reoccur monthly like doctor’s appointments, car maintenance or new clothes. Having wiggle room for unforeseen expenses and less common essential expenses can be a large weight off your shoulders.
Spend money on yourself –
Once you’ve accounted for the essentials, allocate 30% of your take-home pay to spending money on things that you want. What you spend this money on is entirely up to you, and these costs are totally optional. Gym memberships, craft beer, cold-brew coffee, and video games are all items that add to your quality of life and help define who you are, but you shouldn’t let these expenses swallow your money whole.
With our same example, you would have $1,200 out of $4,000 a month to spend on the things that matter most to you. Larger expenses like a new bike or a down payment for a luxury car might be something that you save for over time with money from the Want bucket.
Think about the future –
Most twentysomethings aren’t thinking about stashing away money for the future but the earlier you start saving money brings the day you can retire one day sooner. Allocate at least 20% of your after tax pay to setting aside money for the future. Debt payments should come out of the savings buckets and should be considered an investment in yourself, leftover money in the needs or wants categories can rapidly reduce the timeline in which you can get yourself out of debt.
At first this money could go towards building an emergency fund that could support you for 3 to 6 months or a rainy day fund. With an emergency fund and a solid plan for debt repayment establishing you could start contributing to an investment account such as a 401k or IRA plan to plan for retirement. For a person with $4,000 in take-home pay this would be $800 a month in savings.
The 50/30/20 budget is for people who want to build flexibility into their personal finances but want to remain conscious of how their spend aligns with their values and goals. If you only happen to spend 35% of your pay on your Needs and have contributed the appropriate amount to your savings account, you can certainly spring for that luxury bag or exotic trip if you have planned accordingly for those expenses or trimmed back in certain areas of your life.
Percentage-based budgets make sense for people who have steady income and provide flexibility so you can cut back in areas to free up money for other wants or goals. A percentage-based budget might not make sense if you’re currently in-between jobs or tight on money and need to stretch your money as far as possible.
If you notice you’re spending a significantly higher portion of money on your wants or needs and unable to save for the future, it might be time to re-assess your spending habits and look for cheaper digs or make more meals at home instead of eating out. The 50/30/20 is great at providing a baseline for your spend and provides reasonable buckets of spend for your needs and wants.
Budgeting isn’t about wringing the last few pennies of savings of your grocery bill, it’s about understanding what’s important to you and then putting your money to work in the areas that make you happiest.