The hardest part about budgeting is that a lot of people don't know where to start. Plenty of people are tripped up just by asking "How much should I be spending, and where?" That is what we love about the 50 / 30 / 20 Budget Rules! They provide the "how to" to help you start budgeting today!
Do I Really Need a Budget?
If you are like most people I know, you may not even have a budget. I have several friends who say they don't need one because they start every year hoping to save a certain amount. As the say, they plan on "paying themselves first". But at the end of the year seemingly none of the planned savings seems to materialize.
If this described you, don't worry. You are not alone. According to a recent Gallup poll, just one-third of Americans prepare a household budget each month. The poll also found that most people do not have a long-term financial plan for investments and savings. This leaves most households living paycheck to paycheck.
A common reason many people fail to use a budget is they can be tedious and a bit overwhelming. Many people also have misconceptions about what a budget means. At its most basic, a budget is a way to know how much you need every month for essentials, plan for your future, and still have money left over for the things you enjoy.
If you have tried to budget in the past and failed, the 50 / 30 / 20 Rule to budgeting may be a good fit for you. This simple rule makes budgeting pain-free -- and it works because there are no stringent rules to worry about.
What is the 50 / 30 / 20 Budget Rule?
Budgeting using the 50/30/20 Rule is simple. And that is why it is effective.
What you want to do is divide your net (after tax) income into one of three categories: (1) necessities; (2) lifestyle choices; and (3) financial obligations and goals.
According to the 50/30/20 Rule, your budget will break down like this:
- Spend no more than 50% of your income on necessities like utilities and shelter.
- Spend no more than 30% of your income on lifestyle choices like hobbies, cell phone service, and entertainment.
- Apply no less than 20% of your income to retirement savings and debt payments.
Now that we have the basics out of the way, let's take a look at what should go into each category.
Every month, your budget should focus first on the essentials. You want to get to the point where no more than 50% of your net income should go toward essentials, which will include:
- Utilities (including heat, electricity, and water)
- Transportation costs (including car insurance)
- Health insurance and medication
Note that necessities do not include cell phone service, internet, or cable, as those are optional lifestyle choices that you can do without if you choose.
Since paying for shelter and transportation end up eating up the largest portion of our budgets, it is given the biggest bucket in the 50/30/20 Rule. And now that you know the limit you should be spending on these items, you have the tools to keep these items from swallowing your savings and spending goals.
Financial Obligations & Priorities: 20%
Once your necessities are paid, this category should get your focus before you do other spending.
A minimum of 20% of your net pay should go toward your financial obligations like debt payments and your long-term financial goals, such as your retirement or savings contributions.
For the purpose of your financial obligations, any car and mortgage payments are "necessities", and do not belong in this bucket. The debt in the financial obligations bucket include your student loans, any credit card debt, and other financial obligations you may have - including saving for college.
You should not that the 50/30/20 rule only considers take-home pay, so it will not include any retirement contributions that come out of your paycheck. If you are self-employed and no retirement contributions are taken out of your pay before you receive it, you may need to contribute more than 20% to financial priorities.
This is what makes the 50 / 30 / 20 Budget so powerful - you are not stopping your savings goals with your 401k contributions. You are also building a savings account, and emergency fund, and other savings buckets to draw from throughout your life.
Lifestyle Choices: 30%
A maximum of 30% of your income should go toward voluntary or discretionary spending. This may include may things such as:
- Internet, cable, and cell phone service
- Charitable contributions
- Gym memberships
- Personal care
When you get started, spending in this category should come after you have taken care of essentials and important financial goals. While we don't want you to stop having fun, it may take you time to get your necessities spending into the 50% spending cap.
But once necessities are under control, you will be left with a significant bucket to spend on enjoying life. And you will have a simple budget rule in place to know what context those lifestyle choices should have within your spending.
Is the 50 / 30 / 20 Rule a Good Fit for You?
The beauty of the 50/30/20 budget is it gives you an idea of where your money should go and in which order you should allocate your money each month.
This rule can also help you distinguish betweens needs and wants. Anything you can forgo with no more than inconvenience, such as cable TV or cell service, is a want, whereas needs impact your quality of life, such as medication and electricity.
While the 50/30/20 Budget Rules are not a perfect budgeting tool, their simplicity makes them perfect for anyone who has struggled to budget or needs a bit of help getting started.