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Budgeting is essential to creating a solid financial plan.
There is a lot of budgeting plans there, whether you’re budgeting for irregular income or following a spending plan that puts savings first. But one budgeting method, the 50/20/30 rule, can be a simple strategy for those who are just starting out with a spending plan.
Is the 50/20/30 budget right for you? Read on for everything you need to know about this method of budgeting.
What is the 50/20/30 rule?
The 50/20/30 rule was introduced by then professor (now senator) Elizabeth Warren in her book All Your Worth: The Ultimate Lifetime Money Plan. The rule gained notoriety in 2012 after financial planning company LearnVest popularized the budgeting method.
The 50/20/30 rule divides the money into three separate brackets based on after-tax income, which is your take-home pay. Organizing your funds into these three separate compartments might be easier for people who might be overwhelmed with more detailed budgeting methods.
This is how it works:
- Mandatory expenses represent 50% of your income. This includes mortgage or rent payments, utilities, health care, basic groceries, transportation, and child care costs.
- Savings and debt repayment represent 20% of your income. This means that 20% of your take-home pay should be spent on build up an emergency fund, grow your retirement savings or pay off your credit card debt and / or student loans.
- “Wants” represent 30% of your income. This compartment includes expenses such as cable, internet and telephone charges. Technically, these are non-essential costs that you could live without, like going out to eat or shopping for new clothes.
Crunch the numbers
One of the main attractions of the 50/20/30 budget rule is its simplicity. For this example, consider a person who earns $ 3,800 per month. Applying the 50/20/30 rule would give them a monthly budget of:
- 50% for mandatory expenses = $ 1,900
- 20% allocation to savings and debt repayment = $ 760
- Leaving 30% for wants and discretionary spending = $ 1,140
How realistic do these percentages seem? Let’s break it down. In our example, the necessities include:
- Rent payment, $ 925
- Renters’ insurance premium, $ 25
- Auto payment and insurance, $ 350
- Groceries, $ 200
for a total of $ 1,500. This fits well with the goal of 50% ($ 1,900).
To determine the actual percentage, divide the total of the required items by the total net salary, then multiply by 100 to get the percentage for that compartment. In this example, ($ 1,500 / $ 3,800) * 100 = 39.5% of take-home pay spent on mandatory expenses.
Then, it will be necessary to record the savings and the repayment of the debt. These may include:
- Student loan payment, $ 393
- Credit card or other debt payment, $ 300
- Savings, $ 200
For a total of $ 893. This does not fit the 20% target ($ 760); instead, it represents 23.5% of the net salary allocated to savings and debt repayment.
Finally, let’s look at “desires”. These may include:
- Cell phone bill, $ 100
- Streaming services (Disney +, Netflix, Spotify, etc.), $ 31
- Internet services: $ 70
- Dinner at a restaurant, $ 400
- Shopping, $ 250
For a total of $ 851. This fits well with the goal of 30% ($ 1,140).
In addition to offering simplicity, a percentage-based budget like 50/20/30 can be adjusted to suit individual situations. Based on the examples above, this person could allocate a portion of their “wishing” funds to increase their savings or invest additional money in their student loans each month.
Where the 50/20/30 rule doesn’t work
While the 50/20/30 rule can be a good rule of thumb for individuals, it may be unrealistic for those with low incomes or living in areas with higher cost of living.
For example, Fifty thirty twenty , a project created by a graphic designer for the federal government, illustrates the difficulty of following the 50/20/30 rule on different incomes and different household sizes. The website pulls average income data from the 2014 American Community Survey conducted by the Census (and while it’s a bit dated, it works for illustration purposes) and estimates the take-home pay of ADP Salary Calculator.
The website gives an example of a single adult male living on $ 35,637 a year in Chicago. This person earns $ 2,253 per month after tax. If he wanted to strictly follow the 50/20/30, that would be nearly impossible, due to the costs of his needs such as housing, utilities and health care.
Credit: Fifty thirty twenty
Another example is of a married couple in Boise, Idaho, with two children. This family earns $ 72,104 per year and earns $ 4,482 per month after taxes.
Since their needs represent over 71% of their take-home pay, this family is also unable to strictly follow the 50/20/30 rule. For them, the budget breakers are their health costs ($ 719, according to the Economic Policy Institute (EPI) Family Budget Calculator) and child care costs ($ 887, also according to the PPE calculator).
Credit: Fifty thirty twenty
How to use the 50/20/30 rule to your advantage
This method of budgeting is a good way to start making a habit of integrating savings and debt repayment into a budget. However, following the compartment allocation percentages to exact amounts may not be realistic, depending on your income and the cost of your necessities.
That’s not to say that this method of budgeting isn’t useful, however. Using the amounts in the compartments as a starting point can help individuals identify where they might be spending too much. Someone might find they are overspending on cable or cell phone subscriptions, for example, after calculating how much of their income goes to each category. This valuable information could help them cut costs in their “cravings” section.
If you use the 50/20/30 rule as your budgeting method, you can simplify it further by tracking your expenses on a budgeting app and automate your savings. You need a budget (YNAB), for example, connects to the user’s bank account and allows the user to create categories and designate a target number of expenses in those categories each month.
After planning how much you plan to spend on necessities, savings / debt, and wants, viewing everything in an app can also help keep you on track. More verify accounts allow users to set up recurring transactions on a specific date each month, which can make the recording automatic and effortlessly.
All in all, most experts will tell you that budgets need to be flexible in order to help them work and to ensure that they are adhered to. But it doesn’t matter if you go for the 50/20/30 rule or some other method of budgeting, one thing is for sure: getting a feel for your cash flow, and adjusting your spending based on your long term goals, will set you in place. for financial success.