50-30-20 Budget Rule
There are as many ideas about budgeting as there are financial writers. While it’s important to find a system that works for you, the 50/30/20 rule is an easy way to start. What is the 50/30/20 rule? In a nutshell, it’s a rule of thumb to spend 50% of your after-tax income on needs, 30% on wants, and 20% on savings.
To get started, you need to determine your after-tax income, or bring-home pay. This is the amount of your paycheck after taxes, insurance premiums, retirement contributions, and any other deductions from your gross pay. If you’re self-employed, your after-tax income is equal to your gross income less your business expenses.
The next step is to limit your needs to 50% of your after-tax income. Great, but what is a need? These are the essentials – rent/mortgage, utilities, car payment, credit card payments, groceries, insurance premiums, medication, etc. An easy test to determine a need vs. a want is the pain factor. The more painful it is to give something up, the more likely it is to be essential. Not making your car payment, and ultimately losing your car, is much more painful than losing cable. Therefore, your car payment is a need, while your cable bill is a want.
Speaking of wants, they should total around 30% of your after-tax income. This might sound like a large portion of your budget, but let’s focus on what a “want” is. Some examples – while the internet portion of your cable bill might be a “need” (if it's necessary for work or school), the package that includes premium channels is a “want.” Same with splurges at the grocery store, on clothing, eating out, etc. It’s easy to exceed 30% pretty quickly.
That leaves 20% to spend on savings and debt repayment. (Debt repayment can be tricky. If your car payment is $200, but you pay $300 each month, $200 would go into the “need” category, while $100 would go into debt repayment.) Your initial priority should be to build your emergency fund. (You should have anywhere from 3 – 6 months of living expenses in an easily accessible savings account.) Prioritizing after this is more subjective. If you have high-interest debt, try to refinance/transfer your balance to the lowest interest rate you can find, then concentrate on paying off these balances.
An Example of the 50/30/20 Plan
If your total take-home pay each month is $3,500, using 50/30/20 means no more than $1,750 should go towards your monthly needs. That means you probably can’t afford a $1,500/month rental or mortgage payment unless your utilities, car payment, credit card payments, insurance premiums and other needs aren’t more than $250 each month. If you already have a $1,500 mortgage payment, you should look to see if there’s a way to reduce your payment or other needs to stay within the 50% range. If you can’t come in at 50% or less, deduct money from “wants” to make sure “needs” are covered.
You should then take 20% ($700) for savings and debt repayment. We’re listing this before “wants” to stress how important it is to pay down your debt and to save money. (It’s estimated that at least 40% of Americans can’t come up with $400 in case of emergency, and we don’t want that to be you.)
Finally, if the other categories are on-target, you have $1,050 to spend on your wants. Have fun, but be careful – money never seems to go as far as we’d like.
If you need help putting a budget together, don’t hesitate to contact one of our Personal Bankers. You don’t need to be a customer, and they might be able to help you find ways to save money.