The 50/30/20 budget is a quite simple financial rule of thumb that splits expenses into three groups – needs (50%), wants (30%) and savings (20%) based on your net income.
This financial rule can be a solid starting point for many individuals who have long-term financial goals. But, there’s a lot of confusion when it comes to implementing it. So, here I’m going to explain how you can use this rule in order to save for the future and have financial stability in your life.
A step-by-step guide to 50/30/20 budget rule
Step 1 – Calculate your after-tax income
This income is the amount of money that remains in your hand each month after taxes are taken out. If you’re an employee this step is fairly easy. Look at your payslips, if your employer contributes to a retirement plan, health insurance premiums, or other items on your behalf, add that money back as it is part of your paycheque.
If you work for yourself, or on a contract basis, or seasonally then this step will be complicated. Your after-tax income will be equal to your gross income minus business expenses, plus the amount of taxes you set aside. One easy way is to look at your income tax return of last year, check what your net income was, and deduct your income taxes.
Step 2 – Needs are 50% of after-tax income
These are the things that would alter your lifestyle if you had to survive without them. Not more than 50% of your after-tax income should go to needs.
Here are the most common ones –
- Housing – Rent and mortgage
- Transportation – Car loans, gas, taxi services, repairs
- Utilities – Cell phone bills, electricity bill, water bill, etc
- All type of insurance
- Grooming essentials, basic clothing
- Medical bills
- Credit card debts, student loans, and other minimum monthly payment of debts
Note that some of these expenses are fixed like mortgage payments and insurance premiums. But most others have flexibility in them, such as groceries and clothing expenses. So, try to save the maximum there.
Step 3 – Wants for 30% of after-tax income
These are basically fun things in life, the expenses you do to gather experiences and memories. This is something which you can actually live without, but unless you’re really short on your needs you shouldn’t do it.
Here are some of the most common expenses that can be classified as ‘wants’-
- Entertainment – Movie nights, tickets to sporting events, club memberships, subscriptions, etc.
- Dining out, dinner dates
- Non-grocery foods and drinks
- Gym membership, hobbies
- Home improvements – furnishing, decor, garden expenses, etc.
- All other non-essential shopping – Electronics, books, sporting goods, etc.
If you find that you’re spending more than 30% on wants, then you might want to cut back. After all, they are just your ‘desires’ which can become a never-ending list if you let it, we don’t need them to survive.
Step 4 – Savings and debt repayments for 20% of your after-tax income
This is what goes towards achieving financial stability and your future financial goals. This contribution of 20% not only increases your net worth but also enables you to live without worries and insecurities.
Savings and debt repayments include –
- Savings – Retirement fund, child’s education fees, etc.
- Extra payment on a mortgage
- Building an emergency fund
- Paying off high-interest debts as early as possible
Remember 20% is the minimum amount. If you are able to spend less in the first two categories, consider saving more than 20% here.
Also, you can manipulate this 20% according to your financial goals. For instance, if you have high-interest debt, you would want to devote this entire 20% towards paying it off.
What do you think about the 50/30/20 budget method? Does it appeal to you more than Zero Based Budgeting?
Let us know in the comments