Budgeting is a great way to keep track of your money, encourage saving and make sure that you’re using your financial resources effectively. Still, only about two thirds of Americans even try to create a budget, according to a Debt.com poll.
Budgeting isn’t particularly fun, and it isn’t the kind of thing that you do once and forget about. After you set up your budget, you have to track your spending each month to make sure you’re sticking to it.
50 percent: Needs
There are some expenses that everyone needs to pay, things like food, shelter and healthcare. The 50/30/20 rule states that you should aim to spend about half of your take-home pay on things that you truly need.
It’s important to keep in mind the difference between a need and a want. You might feel like you need a vacation to de-stress or a new video game to play in your spare time, but the 50 percent portion of your budget should go toward true necessities like:
- Health insurance
- Loan minimum payments
- Child care
- Expenses related to finding or retaining a job
Within this category of spending, there are some other rules of thumb to follow. For example, personal finance experts recommend that you should spend no more than 30 percent of your total income on housing. That leaves 20 percent of your paycheck to cover other essentials.
Depending on where you live, keeping your mortgage or rent payment under 30 percent of your income can be difficult. So, you might have to make cuts elsewhere in your budget to keep your needs spending at about 50 percent of your income.
30 percent: Wants
The 30 in the 50/30/20 rule is dedicated to wants. This includes non-necessary, or discretionary spending, on things like gym memberships, trips to the movies, vacations, eating out and streaming-service subscriptions.
People aren’t robots who wake up, go to work, and come home and get ready for the next day. Everyone needs some fun in their lives, so it’s important to take some time to relax and spend some money on things that you enjoy.
Setting aside a specified portion of your income on tickets to a concert or a weekend getaway at the beach can help reduce spending-related guilt. It will also help you make sure you don’t overspend, causing you to have to go without necessities until your next paycheck.
20 percent: Savings
Saving money for the future – and emergencies – is also important. Everyone should have an emergency fund and today is the best time to start saving for retirement. In recognition of the importance of saving, the 50/30/20 rule argues that you should dedicate a fifth of your income to savings and investments.
How you save money will vary based on your financial situation.
One of the first things that you should do is build a modest emergency fund that you can tap if you encounter an unexpected expense, such as a car repair or health-related bill. Experts usually recommend having an emergency fund equal to three to six months of living expenses.
If you have debt, like credit card or student loan debt, you can dedicate a portion of your savings to making additional payments to pay down your balances. This will get you out of debt more quickly, freeing up space in your budget in the future. It also helps you save money on interest payments.
If you’re saving for retirement, consider investing in tax-advantaged accounts like 401(k)s and IRAs that let you deduct all or part of your contributions from your income when you file your taxes.
Using one of these tax-friendly retirement savings accounts funded with pre-tax dollars can let you save more than you otherwise would.
Is the 50/30/20 rule budget right for you?
The 50/30/20 rule is a great rule of thumb for many people. It reduces the need to create a detailed budget with precise spending amounts and a dozen or more line items, while also providing a framework you can use to make financial choices.
However, some people might not earn enough to limit the needs portion of their budget to just 50 percent.
Chicago-based financial planner Henry Gorecki offers his own take on the 50/30/20 rule. “I usually suggest a budget where 70 percent goes toward needs, 10 percent retirement, 10 percent savings, and 10 percent fun. If someone can reduce needs to 50 percent, even better!”
Breaking down your savings by dividing it between retirement and non-retirement savings is also a good way to save for the future while building an emergency fund for a rainy day.
The 50/30/20 rule also has some drawbacks. The rule can break down for people with low or high incomes. Someone who works a minimum-wage job might have to dedicate more of their income to necessities, leaving themselves with less money to spend on wants and less money to save.
On the other end of the spectrum, a highly paid executive who makes $1 million per year probably doesn’t need to spend $40,000 on necessities each month. Instead, the executive could dedicate more of his or her income to saving, providing an opportunity to retire early.
“The main thing is to use this suggestion as a template or goal, and not something set in stone,” Gorecki says. “Folks living in high-cost areas of the country, like major cities on the East and West Coast, may have to spend more on needs, at least initially, and cut back elsewhere.”
Still, for most people, the 50/30/20 rule is a good budgeting rule to follow, as you don’t have to follow it perfectly for it to be effective. If you do your best to stick to a 50/30/20 budget, you’ll be able to build up your savings and still have some money left to spend on fun things.
The 50/30/20 budgeting rule is a useful rule of thumb that you can use as a guide when planning your spending and savings. While the rule isn’t perfect in every situation, it can provide a framework to follow when making financial decisions and help you build up your savings and pay down your debts over time.
Source: MSN Money / Featured image by snowing – www.freepik.com