What is the 50/30/20 budget rule?

The 50/30/20 rule is a budgeting strategy where you spend 50 percent of your income on essential needs, 30 percent on wants and 20 percent on savings.

50 percent for needs

Needs are things you absolutely must have. The 50/30/20 rule says you should spend about half of your take-home pay on these essentials. Some examples of needs include:

  • Housing
  • Groceries
  • Utilities
  • Health insurance
  • Transportation
  • Loan minimum payments
  • Child care

There are some additional rules of thumb to consider within this category. For example, personal finance experts recommend that you spend no more than 30 percent of your total income on housing. That leaves 20 percent of your paycheck to cover other essentials.

Depending on where you live, keeping your mortgage or rent payment under 30 percent of your income can be difficult. You might have to make cuts elsewhere in your budget to keep your needs spending at 50 percent of your income.

30 percent for wants

Wants include non-essential spending, or discretionary spending, on things like gym memberships, trips to the movies, vacations, dining out and streaming-service subscriptions.

These expenses can include:

  • Hobbies
  • Dining out
  • Vacations
  • Gym memberships
  • Movie tickets
  • Concerts

Everyone needs some fun in their lives, so it’s important to take some time to relax and spend some money on things that you enjoy. Setting aside a specified portion of your income gives you the ability to buy a new outfit or book a weekend getaway and still maintain your budget.

20 percent for savings

One-fifth of your income should go to savings and investments. Everyone should have an emergency fund, and today is the best time to start saving for retirement. How you save money will vary based on your financial situation.

One of the first things you should do is build a modest emergency fund for when you encounter an unexpected expense, such as a car repair or health-related bill. Experts usually recommend having an emergency fund equal to three to six months of living expenses.

If you have debt, like credit card debt or student loan debt, you can dedicate a portion of your savings to making additional payments to pay down your balances. This will get you out of debt sooner, freeing up space in your budget in the future. It also helps you save money on interest payments.

If you’re saving for retirement, consider investing in tax-advantaged accounts like 401(k)s and IRAs that let you deduct all or part of your contributions from your income when you file your taxes.

Using one of these tax-friendly retirement savings accounts funded with pretax dollars can let you save more than you otherwise would.

An example of a 50/30/20 budget

Here’s an example of the 50/30/20 budget in practice.

  1. Determine your income. Let’s say you have $2,000 deposited into your bank account each month from your job. An additional $100 was deposited into your 401(k). That gives you a total monthly income of $2,100. If you are paid biweekly, there may be months where you receive three paychecks. Identify those months and adjust your total income accordingly.
  2. Apply the spending thresholds. If you used the 50/30/20 rule, you’d allocate $1,050 for needs ($2,100 x 0.5), $630 for wants ($2,100 x 0.3) and $420 for savings ($2,100 x 0.2).
  3. Plan your budget around these figures. Take a look at your current spending and plan to adjust it to these dollar amounts in future months.

50/30/20 budget example

Needs ($2,100 x 0.5)$1,050
Wants ($2,100 x 0.3)$630
Savings ($2,100 x 0.2)$420

Is the 50/30/20 rule budget right for you?

The 50/30/20 rule is a great budgeting strategy for many people. It reduces the need to create a detailed budget with precise spending amounts and a dozen or more line items and also provides a framework you can use to make financial choices.

Dividing your savings between retirement and non-retirement savings is also a good way to save for the future while building an emergency fund for a rainy day.

The 50/30/20 rule may not work for people with very low or high incomes. Someone who works a minimum wage job might have to dedicate more of their income to necessities, leaving themselves with less money to spend on wants and savings. On the other end of the spectrum, a highly paid executive who makes $1 million per year probably doesn’t need to spend $40,000 on necessities each month.

What experts say about the 50/30/20 rule

Here’s what financial experts say about this budgeting rule of thumb.

Greg McBride, CFA, Bankrate chief financial analyst: “Many households may have difficulty implementing the 50/30/20 budget because they’re currently hemmed in by high housing, insurance, and child care costs that push them well above 50 percent of net income. In any event, start with the savings component by automating retirement and emergency savings contributions via payroll deduction or automatic bank transfer and look to increase the amount you’re saving with each pay raise and every time you pay off a debt.”

Chloe Moore, CFP, founder of Financial Staples: “The idea of setting up a budget can be intimidating or confusing. This strategy provides a relatively easy guideline. You can also evaluate our current spending and savings against this strategy as a way to see how you measure up. It can be hard to sort out wants and needs, and these categories are very subjective. For example, food is a need. Some groceries could fall into the need category while other groceries or dining out could be considered a want.”

The post What is the 50/30/20 budget rule? appeared first on Bankrate

Original source: Bankrate

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