When creating a budget, it can be challenging to know how much money to put toward which expenses. Yet, having a plan helps you make better overall spending decisions. One way you can do this is through the 50/30/20 rule. With this method, 50% of your income is put towards the things you need, 30% goes towards things you want, and you tuck that final 20% into savings. Here's how it works.
50% Needs
The first 50% of your income goes towards necessary purchases, which you must pay for the basic necessities of life. This could include:
- Rent or mortgage payments
- Car payments
- Insurance
- Minimum debt repayment on loans
- Groceries
- Health care
Things that go into the "Needs" category are items you must have to continue to meet your basic physiological requirements. That excludes things you consider 'essential,' such as your morning coffee shop run or favorite streaming service. If you are spending more than 50% on your needs already, you'll need to find a way to reduce them or increase your income. Finding ways to trim back your needs is always a good idea, but do so wisely, recognizing that paying for your needs is typically more important than funding "Wants."
30% Wants
The second step is to put 30% of your income towards things you want. This includes those coffee shop purchases, streaming services, or dining out. It also includes clothing purchases, electronics, and other items you want to spend money on. Some other examples include:
- Movies
- Vacations
- Hobbies
- Gym memberships
- Subscription services
- Nonessential clothing purchases
When making buying decisions, focus on this figure. For example, if you are considering buying a new car, be sure that the added car payment for the higher-end vehicle (the more expensive model) fits within your 30% goal. If it doesn't, choose a more affordable model.
20% Savings
Put 20% of your income into your savings each month as well. That can include traditional savings accounts and investments like retirement accounts and mutual funds. This can seem like a steep amount to save, but your savings help reduce the risk of not having money available during an emergency or when it's time to retire. It can also help you save up for goals like buying a home.
If you lose your job, it's your savings that are going to help you to continue to pay for your "Needs" items. That's why putting at least 20% of your income into savings should be considered essential.
Building an Example Budget
Let's create a budget that explains how this may work for someone. Follow these steps for those planning to use the 50/30/20 budget.
Determine your income
Add up all of your income for the month. Let's say you bring home $3,000 each month. Your employer also puts $100 into your 401(k) each month. Your total income is $3,100. Now, apply the 50/30/20 rule. This means that you would do the following:
- 50% of $3100 is $1550. That means you have $1,550 to put towards your needs each month.
- 30% of $3100 is $930. You should put $930 towards your wants each month.
- 20% of $3100 is $620. You should put $620 towards your savings each month.
The next step is to ensure you allocate the funds for each category. For $1550, you need to pay your rent, car loan, insurance, and so on. In your wants category, you should cover any purchases you have to make for things like dining out or subscription services. For savings, $100 is already going into your 401(k), so the remaining $520 should be put into savings accounts or investment accounts.
Is the 50/30/20 Budget Right for You?
There are various benefits to using this method, including the fact that it helps you build your savings quickly. This method can work if your income is high enough to cover your needs, which may only be the case for some.
This method may not work out if you have a meager income. For example, if you earn a smaller amount each year, most of your income will go towards your needs, with less going towards wants and savings.
The 50/30/20 is a difficult one to put into place because of how much your needs may be. However, if you can, this method can be ideal for building your savings and keeping your spending in line with your goals.