The 50 30 20 rule for budgeting helps you keep on top of your finances while still giving you the freedom to enjoy your money.
It is important to have a budget to get a good handle on your finances. With a budget, it is easy to know your monthly income and how your expenses.
While some people create a budget, others find it hard to plan ahead on how to spend their income.
With the 50-30-20 budgeting rule, you can have a monthly budget that helps you save for the future. If you have no idea where to start when trying to create a budget, consider the 50-30-20 budget rule.
What is the 50-30-20 Rule?
The 50-30-20 rule is a budgeting method that can help you manage your money effectively. Ideally, the rule enables you to divide your monthly income (after tax) into three categories, i.e., needs, wants, and savings.
If you follow this rule, it is easier to track your spending and save money in the long run.
According to the 50-30-20 rule, you should break your monthly net income into three parts:
- 50% for essentials like rent, gas, groceries, etc.
- 30% for savings, for example, retirement plans, credit card payments, and loans
- 20% for everything else, including gyms, clothing, and monthly streaming contributions
Dividing your net income into three categories helps you keep track of your spending habits without going overboard.
The three categories cover most expenses, and you can easily determine how and what to spend money on. With the 50-30-20 rule, you can achieve your long-term financial goals without compromising your quality of living.
How to Use the 50-30-20 Rule
Essentials: 50% of the Net Monthly Income
Essentials refer to items or expenses we cannot live without. Most of the net income should cover these expenses to make your life easier and more valuable.
Take your time to know the expenses you cannot avoid and include them in this category. Some of the essentials include:
- House payments, i.e., rent or mortgage
- Utility bills, i.e., water and electricity bills
- Insurance, i.e., healthcare and car
If the expenses exceed 50% of the monthly income, you need to make some adjustments. You can relocate to another house, choose a different utility provider or save money when buying groceries.
The main objective here is to reduce the cost of living considerably. We all have different needs and wants, and it is up to you to determine what you cannot live without.
Wants: 30% of the Net Monthly Income
Wants refer to non-essential expenses which enhance your lifestyle. Although they improve your quality of life, you can live without them. The wants include:
- Gym membership
- Entertainment subscriptions, e.g., Netflix, HBO, and Amazon Prime
- Dining out
- Buying clothes
When it comes to wants, it is much more of a personal decision. You can decide what to buy depending on your preference and need.
For example, although you need a cell phone plan to communicate with friends and family, you can choose a cheaper plan to pay for depending on your income.
It is important to understand that the 50-30-20 rule is not supposed to make your life miserable.
Instead, it should help you become more conscious to avoid spending your money on things you do not need. Remember, spending less on wants enables you to repay debts and save money to secure your future.
Savings: 20% of your income
The final category in the 50-30-20 rule is saving 20% of your income towards savings or paying back loans. In this category, you can have a saving plan, emergency fund, retirement benefits account, or debt repayment plan.
The primary objective is to plan ahead and strive towards being debt free. Saving 20% of your monthly income helps you become disciplined and focused on achieving financial freedom.
How to Apply the 50-30-20 Rule
Knowing how and when to apply the 50-30-20 rule is important. If you want to achieve financial freedom, here is a step-by-step guide on how to use the 50-30-20 rule:
i. Calculate your after-tax income
The first thing is to know your monthly income after tax. Calculating your after-tax can be tricky if you are a business owner or freelancer. However, your after-tax income is the gross income minus business expenses or tax deductions.
On the other hand, if you are an employee, after-tax income is the amount of money you receive in your bank account. Remember, if there are automatic deductions, such as pension funds and health insurance, add them back to budget your monthly income accurately.
ii. Categorize your monthly spending
Carefully categorize how you spent your last month’s income. It is easier to check your bank statement to know how and where you spent your income.
While categorizing the expenses, remember that needs are expenses you cannot live without, e.g., rent, while wants are expenses to improve your life, and you can live without them, e.g., gym membership and TV subscriptions.
After carefully categorizing your expenses, you can easily know what to remove or include to fit your needs.
iii. Evaluate your spending to match the 50-30-20 rule
Divide the after-tax income to match the 50-30-20 rule depending on your needs, wants, and savings. You must cut back if your monthly income cannot meet all your needs and wants.
Take your time to determine the wants you can cut back to save money. The more you reduce your wants, the higher the chances of hitting the 20% saving target. It might seem straightforward to budget your monthly income, but it is quite challenging.
Is the 50-30-20 rule right for you?
Although the 50-30-20 rule clearly describes how to budget your monthly income, it might not work for everyone. We are different, so we have different needs, wants, and spending habits.
Therefore, the 50-30-20 rule should provide a framework for you to work within. Following the 50-30-20 rule helps you control your spending habits and understand the savings concept.
It is crucial to keep track of all your expenses. Therefore, remember to save your cash receipts and get your card statements each month to see whether you are overspending in certain areas.
Finally, if creating or maintaining a budget is challenging, consider seeking advice from a financial advisor.