You may have heard of the 50/30/20 rule when it comes to planning a budget. But what does this mean? By the end of this post, you will understand the basics of the rule, and be able to implement it in your own budget.
The 50/30/20 rule is just saying that, as a general rule, a maximum of 50% of your after-tax income should be going to necessary expenses; 30% should be going to your “wants” expenses, and 20% should be going into your savings/ investment accounts. Just in case you didn’t notice, 50+30+20 adds up to 100% of all your after-tax income.
The 50%: Necessary Expenses
This is the first and biggest mistake that many people make when making those big financial decisions- no more than half of your after-tax income should be going towards your necessary expenses. What are necessary expenses? These include the very basic necessities for your survival: housing, utilities, food (not eating out, but basic food needs). Most people, especially when just starting out, spend way too much on their housing. This could mean a person with a $30,000 a year net income spending a full $1100 a month on rent, when, based off of this rule, all of their necessities shouldn’t be more than $1250 a month. This severely limits their resources, within the suggested budget, for food and other necessities.
The 30%: Unnecessary Expenses, AKA Wants
Also known as “discretionary spending”, your unnecessary expenses can really kill your budget. This includes categories like your phone bill (I know it’s hard, but there is usually a cheaper plan out there), clothing, make-up, games, movies, and the like. This is anything that you don’t need for basic survival. The good news is this is the easiest category to cut back on. I know it hurts, but in order to save the way you need in order to achieve the lifestyle that you want, you have to keep this category to a maximum of 30% of your total net income.
The 20%: Saving and Investing
At least 20% of your income should go straight into a savings or retirement account. This money should be used for a rainy day fund or as a retirement vessel. This is a really hard one to do, which is completely understandable, but you should know that wealthy people became wealthy by maximizing this category and minimizing the other two categories. If you want to create a comfortable and healthy lifestyle for you and your kids, any extras that you save from the first category should go here, into saving and investing, and not into the discretionary spending category.
And There You Have It
This is, in short, where your money should be going: maximum 50% towards basic living necessities, 30% to discretionary spending, and at least 20% towards savings and investing. These are, obviously, basic guidelines, but they are a good start for you to analyze your spending to see if you fall within the guidelines or if you need to make some changes.
We will be exploring what each of these categories means, in depth, coming soon!