If you find your bank account balance nearing the single digits, you may be ready to take a close look at your finances.
Or maybe you’re handling the regular expenses comfortably, but your savings account isn’t where you want it to be. Does the idea of budgeting cause you to break out in a cold sweat or shrink in fear? You’re not alone. The 50/20/30 rule may ease your fears and make budgeting more straightforward. This budgeting tactic aims to help you know where your money is going each month without having to micro-manage every penny. Sound good? Let’s dig in.
The 50/20/30 budgeting method recommends that you divide your after-tax income into three categories:
- Necessities – 50% of income
- Savings – 20% of income
- Wants – 30% of income
What is the 50/20/30 rule of thumb?
A maximum of 50% of your take-home pay should go toward living expenses. Housing payments, groceries, and transportation are examples of items that fall within this category.
The “20” of the 50/20/30 rule means you’ll use 20% of your budget to fund savings goals, retirement contributions, and extra debt payments.
NOTE: You should include minimum required debt payments under Necessities, not Savings.
The remaining 30% of your paycheck can be used for eating out and other entertainment expenses.
So, if you have $3,000 per month in after-tax income, your budget would breakdown to:
- $1,500 for Necessities
- $900 for Wants
- $600 for Savings
The $1,500 (Necessities – 50%) would cover such things as:
- Transportation (car payment)
- Car insurance
- Minimum debt payments (credit cards, student loans, etc.)
- Healthcare insurance
This category would not include cable package subscriptions, internet services, or gym memberships.
The $600 (Savings – 20%) can include such things as:
- Retirement plan contributions
- Emergency fund savings contributions
- Savings for a large purchase, special event, or occasion
- Additional payments toward debt reduction
Use the remaining $900 (Wants – 30%) on anything you desire, including entertainment, internet services, or a gym membership.
How can the 50/20/30 rule help guide my financial choices?
You can use the 50/20/30 rule to decide if your budget is on target. Begin with the Necessities. Once you’ve established your 50% figure, you have the flexibility to increase certain expenses while decreasing others within that category. For example, can you handle an increase in rent or a new auto loan payment? Or do you need to cut some of your other costs first? As long as the total doesn’t exceed the designated percentage, congratulate yourself for sticking to your budget!
If, however, Necessities exceed 50% of your monthly paycheck, you might need to relocate or reduce other expenses within that category.
Are there exceptions to the 50/20/30 rule?
Yes, the budget breakdown serves as a guideline. The cost of living in your geographic location may require you to spend slightly over 50% in the Necessities category. You might also have other factors influencing your spending, such as ongoing medical expenses that could shift your budget percentages.
If you’re paying off a sizable amount of credit card or student loan debt, modify the formula to help meet your financial goals. For example, if you have a high student loan balance, you could limit your Wants to $600 and put the extra $300 per month toward paying down the loan balance instead.
When applied to your current spending, the 50/20/30 budget rule can quickly identify where you might be overspending. Just like anything else, the budget only works if you stick to it.