50/20/30 Budgeting Rule
A roadmap for short- and long-term financial health
You’ve probably heard by now that making and sticking to a budget is one of the most important ways to ensure that your financial health remains in good standing. Maybe you’ve even calculated your budget by understanding how much you spend on your needs vs. wants, and how much you want to save for the future. Great! You’re definitely on the right track. A recent Gallup poll indicates that only 32 percent of Americans actually keep a household budget. But how do you know that your calculations are setting you up for short- and long-term financial success? A new budgeting method, coined the “50/20/30 rule,” has been gaining momentum in recent years and provides a roadmap for organizing your budget so that you spend and save ideal amounts of your income. The basic rule is to divide after-tax income, spending 50 percent on needs, directing 20 percent to savings and spending 30 percent on wants. It’s easy to set up your budget using the rule by following these simple steps:
Understand Your After-tax Income
It’s common practice to state your gross income when asked how much you make when applying for a loan or credit card. When it comes to creating your budget, however, it’s important that you start with your after tax income. Why? Because your actual take home pay can be significantly lower than your gross income once state, local and income taxes, as well as Medicare, Social Security, and any other benefit premiums are deducted from your paycheck.
Most people create monthly budgets because the majority of household expenses are paid on a monthly basis. To calculate your monthly after-tax income, simply take the after-tax amount on your check (the amount you are actually paid) and multiply it by the number of times you get paid each month. If your paycheck amount varies from check to check, you may want to calculate your monthly pay based on the average amount you make each check.
Limit Your Needs to 50 Percent of After-tax Income
Now that you know your after-tax monthly income, it’s time to tally up your needs to ensure that they cost at or below 50 percent of your after-tax income. Needs are things that are crucial to your survival and/or living a comfortable life such as a home or apartment, electricity, running water, heat/air conditioning, transportation, food, medical care, and weather appropriate clothing as needed for yourself or your children. It’s important to note that minimum payments on outstanding debts can also be considered a need because not paying them could harm your credit score and your future financial health.
If you add up the amount you spend monthly on needs and determine you spend more than 50 percent of your after-tax income, look for ways to cut out or reduce the amount you spend. Maybe you can buy more generic brands at the grocery store or switch to a generic medication? Consider running your heat or air conditioner less often to lower your utility bills. Or, shop the clearance racks for clothing or visit a consignment store where gently worn clothing is sold for a fraction of the price.
Limit Wants to 30 Percent
You work hard and think you should be able to spend your money on the things you want that make life enjoyable. You are totally right - but be careful not to go overboard. Eating meals at restaurants, enjoying a fancy latte from a coffee shop, indulging on new seasonal wardrobes, purchasing high-end cosmetics, even your unlimited data plan and cable bills are all wants. Enjoying these niceties in moderation most likely won’t kill your budget. Enjoying these niceties too often or in excess just might. So go ahead and enjoy them in moderation, but keep your total spending under 30 percent of your after-tax income.
It may surprise some to see an unlimited data plan and cable bill listed as a want and not a need. While a data streaming fanatic or a movie buff might disagree, these items aren’t necessary for survival. They are simply nice-to-have, modern-day conveniences. So if you find these or other expensive things like them listed in your needs budget, move them to wants and adjust your spending accordingly.
Put 20 Percent Toward Savings and Debt
The remaining 20 percent of your after-tax income should be allocated to paying off past debts and saving for the future. Examples of debts include student loans, credit cards and car loans. Remember, the minimum payments due each month are considered a need since not paying them would hurt your credit score. Any amount above the minimum payment counts toward the 20 percent in this category.
Your savings should be allocated toward building an emergency savings fund and saving for retirement. By doing so, you will more likely be able to cover the unexpected expenses that life throws at you, as well as meet your long-term retirement goals. It’s also important to note that going over the 20 percent is a good thing. If you have a month where you spend less than expected on needs and wants, go ahead and put that extra money toward savings or repaying debts. Your future self will thank you.
The 50/20/30 rule is an easy and flexible way to help you budget your money. With a little bit of patience and persistence, you will soon see the benefits of understanding you after-tax income and analyzing your spending in order to save money and secure short- and long-term financial health.