If you’re having trouble finding the right balance for your budget, you should consider giving the 50/30/20 rule a try. It’s where you divide your income into three separate categories (needs, wants, savings) to help conquer your savings and spending goals. Let’s break down exactly what that looks like!
50%: Needs
Knowing the difference between needs and wants is the first rule of personal finance. It’s also the first step in understanding and implementing the 50/30/20 rule. Your needs are the necessities of life and other important financial obligations you must pay for. Wants, on the other hand, might improve your quality of life, but aren’t essential for survival. Needs may include housing, utilities, food, transportation, clothing, loan payments, insurance, and healthcare. Set aside half of your after-tax income to pay for these necessary expenses. If your needs are more than 50% of your monthly income, you’ll need to cut out some of your wants to cover the extra costs.
30%: Wants
It’s easier to stay motivated to save when you include some budgeting room for buying the things you want. Once you’ve accounted for all your needs, set aside 30% of your monthly income to pay for things that make life a little sweeter. These may include non-essential clothes, entertainment, vacations, eating out, etc. Anything that’s not absolutely necessary to sustain life fits into this category. Just be careful not to overindulge or confuse needs with wants. Your budget will balloon fast if you include expensive clothes, eating out every night, or a house payment you can’t afford as part of your “needs” analysis.
20%: Savings
Prioritizing savings is part of every good budget plan. The 50/30/20 rule ensures that you save 20% of your monthly income to pay for emergencies and future events like retirement. You might choose to open a savings account or put your money in the stock market or a retirement account. No matter how you decide to save, keep your contributions consistent. Saving at least 20% of your after-tax income can help you build your wealth and avoid the financial pitfalls of living paycheck to paycheck and incurring excess debt.
How to Get Started
The simplicity of the 50/30/20 rule is one of the reasons it’s such an effective budgeting tool for so many people. If you know how to calculate your after-tax income and categorize and evaluate your spending, you can put the 50/30/20 rule into practice in your own financial life.
Calculate Your After-Tax Income
If you use your pre-tax gross income as the basis for your 50/30/20 rule calculation, you’ll end up factoring for more than 100% of your money. Instead, use your after-tax income for a more accurate accounting of your income and costs. To find your after-tax income, you’ll need to know your total taxable income and your tax rate. If you work for an employer that takes out taxes from your paycheck (and you want to simplify this calculation), just use the money that you receive each paycheck. Just be sure that you’re withholding an adequate amount of taxes (or otherwise account for taxes in your needs analysis), so you don’t have to use all your savings to pay for a big tax obligation at the end of the year.
Categorize Your Spending
Look at your income and expenses for the past several months and categorize each purchase as either a need or a want. Find out how much of your income you saved and determine what percentage of your purchases were needs and wants. Are you close to the 50/30/20 rule or do you have work to do?
Make Adjustments as Necessary
Use your spending history as a baseline for your new budget. Keep track of every expense moving forward, so you can know when you’re nearing your budgeted limits for each category. If you’re spending more than 50% on needs or more than 30% on wants, make adjustments to your spending habits or your budget itself. While the 50/30/20 rule is a great goal and a reasonable rule to follow, your financial situation may look a little different, and that’s okay! Maybe your personal plan will look more like the 60/20/20 rule. Just be sure to prioritize saving 20% of your income and that you’re able to pay for all your necessary expenses.
Monthly 50/30/20 Budget Calculator
Following a budget is rarely easy, even ones as simple as the 50/30/20 rule. If you need help to ensure that you stick with your new savings and spending plan, consider using a 50/30/20 calculator. These calculators will let you input your after-tax income, divide every dollar into needs, wants, and savings categories, and help you track your monthly spending and savings goals.
The Importance of Saving Money
At the end of the day, saving money is what matters most. Yes, the 50/30/20 rule will help you meet your financial responsibilities and ensure that you have enough money left over to purchase a few things for yourself. But no matter how you divide your dollars, the 20% savings rule is why most people start this plan in the first place. Saving money leads to greater financial security and opens up more opportunities for your money to help you build wealth and live a more comfortable life.
Get More Help with Monthly Budget Planning with Merrick Bank
The 50/30/20 rule is a great way to get started on your budgeting plan. It allows you to divide your dollars and portion out your payments, so you can conquer your savings and spending goals. If you’re struggling with your budget strategy, try the 50/30/20 rule to refocus your finances and simplify your savings and spending. To learn more about managing your money and building a better budget, check out our other helpful financial and educational resources.