If you’re a little overwhelmed with where to start, no need to worry. The 50/30/20 budget rule simplifies the process more than most other budgeting strategies. It works off of 3 different percentages that easily break down to fit your financial situation.
Now that you know the plan divides your income into 3 broader categories: needs, wants, and savings, here’s a closer look at each bucket and how it all breaks down.
Simply put, these are the must-haves or essentials: the things you absolutely need to get by in the day to day. Fifty percent of your after-tax income should cover your most necessary costs.
Examples: rent or mortgage payments, utility bills, health insurance premiums, groceries, a mass transit pass, gas for your car.
Expenses like car payments, minimum credit card payments, and other debt responsibilities also fall under your needs. While these needs may be easy enough to remember, one missed payment could do some damage to your credit score. And having tip-top credit helps future you. How? It plays a major role in making sure you can snag decent terms and interest rates on future cards and loans.
This budget may differ from one person to another. If you find that your needs add up to much more than 50% of your take-home income, you may be able to make some changes to bring those expenses down a bit.
This could be as simple as changing your internet provider or finding some new ways to save money while shopping. It could also mean exploring bigger life changes, such as looking for a less expensive living situation.
This is the fun bucket: all of the things you enjoy but aren’t necessarily essentials. Anything in the “wants” bucket is optional if you boil it down.
Examples: eating out, clothes, electronic gadgets, money spent on hobbies, vacations, that Netflix subscription.
How can you separate your needs versus your wants, especially if they’re currently lumped together in your brain as being of equal importance?
Look at it this way: In addition to not being essential to living your life, the cost of your wants may fluctuate month to month, whereas the cost of your needs typically stay the same. For instance, rent and the internet bill are always the same amount, and the gas bill is usually around the same cost each month as well. However, entertainment or clothing costs unregulated could vary every month, threatening your budget. That new gaming console, when you already have 3? Since you’ll most likely survive without it, that’s a want.
Also, keep in mind this category can include luxury upgrades. For example, if you decide to purchase a nicer car instead of a less expensive one, that dips into your wants category.
Don’t feel guilty about the things you do want and spend your money on in this category. That’s what it’s there for, but be mindful of how much you’ve allocated to this bucket, and do your best to stay within the parameters you’ve set for yourself.
Savings & Debt (20%)
Here, we’re talking about all things related to savings, debt, and other financial goals.
Examples: emergency fund, retirement account, debt payments, etc.
Often, this bucket gets neglected and might be considered the least exciting to put your money toward. That’s because your income can easily get taken over by your needs, which are obviously important, and your wants, which inevitably have a natural appeal.
If you’re struggling with how to parcel out that remaining bit of your take-home pay between savings and debt, start by focusing on your emergency fund. Why’s that? Well, if you don’t have at least 6 months of living expenses set aside in the case of a sudden event or job loss, your finances will otherwise take a big hit. If you can swing it, aim to set aside at least 20% of your paycheck to cover this base first.
After that’s taken care of, you can move on and have this bucket of money go toward other savings goals or investments. This may include making individual retirement account (IRA) contributions to a mutual fund account or investing in the stock market. And, if you have access to a 401(k) account through your employer, it can be a great way to save a portion of your income pre-tax.
This category for savings can also include debt repayments. While minimum payments are part of the “needs” category, any extra payments that reduce the principal and future interest owed are considered savings. Only debt payments above the minimum payment required should be considered in this savings category.