by Paladin Editorial
According to a media report, nearly 46% of American cardholders carry their debt from one month to the next. As per the Federal Reserve Bank of New York, USA’s total household debt in the last quarter of 2022 was $16.9 trillion. Also, in the fourth quarter of 2022, credit card balances shot up by $61 billion, while mortgage balances increased by $254 billion. All these stats point to one thing – a need for individual financial planning and budgeting.
There are countless budgeting methods available, each with its own complexities. One method – the 50-30-20 rule – stands out, providing a simple and effective solution to financial planning. The 50-30-20 rule involves dividing your after-tax income into three categories: 50% for needs, 30% for wants, and 20% for savings and debt repayment. One of the advantages of the 50-30-20 rule is that it helps balance your current lifestyle and future financial goals. By allocating a percentage of your income to savings and debt repayment, you invest in your financial future without sacrificing your present needs and wants.
Following the 50-30-20 rule can be a great starting point to grow your finances in the future, as a sizable amount is being set aside right at the beginning of the month for investments or reducing debt. However, it’s important to note that everyone’s financial situation is unique. Consider consulting with a financial advisor who can help you assess your current financial situation and develop a savings strategy to help you build wealth over time.
Read below to understand the 50-30-20 budgeting rule and how to implement it to manage and grow your finances.
What is the 50-30-20 rule?
The 50-30-20 rule was popularized by U.S. Sen. Elizabeth Warren. It is a budgeting strategy that provides a balanced approach to managing finances. Using this rule, you can allocate your income into three categories – needs, wants, and savings. One of the advantages of this rule is its simplicity, making it easy for individuals to adopt even if they are new to budgeting and saving. The 50-30-20 rule helps to prioritize long-term financial goals such as building an emergency fund, saving for retirement, or paying off debts. This rule can also bring a sense of discipline in managing finances.
Let’s further understand how to budget with the 50-30-20 rule step-by-step.
Also see: 5 Key Tips to Get Your Personal Finance Organized
4 simple steps to start budgeting with the 50-30-20 rule
The 50-30-20 rule lays a simple framework for income allocation. Below is a step-wise guide to effectively implement this budgeting rule.
Step 1 – Calculate your post-tax/take-home income
After-tax income is what you are left with after accounting for the following common deductions:
- Local tax
- State tax
- Income tax
- Medicare payments
- Social Security payments and others
However, keep the following in mind based on your occupation type:
- If you are a conventional employee, go through your recent paychecks to calculate your take-home income, applicable deductions, and credits.
- If you are self-employed, deducting business expenses and taxes from your gross income will give you the after-tax number.
In either case, while calculating your total income, include any additional sources, if applicable, like commissions, spousal support, or child support.
Step 2 – Set aside 50% of your income for needs
The ‘needs’ category encompasses expenses that are vital for survival and must be paid for regardless of circumstances. These expenses may include rent or mortgage payments, credit card bills, transportation costs including car payments and insurance, healthcare, groceries, minimum debt payments, property taxes, childcare, and any legal obligations such as alimony or child support. To ensure financial stability, it is recommended to evaluate one’s expenditure patterns to determine if more than 50% of income is being allocated towards these necessary expenses. If this is the case, it may be necessary to reduce costs in one or more of these areas. This could involve downsizing to a smaller residence, using public transportation instead of private vehicles, and more.
Step 3 – Allocate 30% of your income to wants
The ‘wants’ category refers to non-essential things an individual may desire to indulge in or enjoy. These wants typically include entertainment, dining out, streaming services, extracurricular lessons, beauty and spa treatments, vacations, cable bills, luxury apparel and shoes, gadgets, and other similar experiences. Indulging in wants is natural; however, it is essential to balance your wants and needs to maintain a healthy financial life. To manage wants, one can prioritize and allocate funds accordingly, setting aside a portion of their income for leisure and entertainment. The 50-30-20 rule emphasizes that individuals may set aside 30% of their income for such expenses.
Step 4 – Set aside 20% of your income for debt and savings
The 50-30-20 rule directs that individuals allocate 20% of their income toward paying off debts and building up their savings. By putting aside a portion of your monthly earnings towards debt repayment, you can pay off your debts quicker and save money in interest payments over the long run. Also, the journey to successful retirement planning can start with this rule. By allocating a significant portion of your income to savings and retirement planning, you can work proactively towards securing your financial future. Also, saving for retirement allows you to take advantage of compound interest, which can help your corpus grow over time.
Individuals that have trouble saving 20% of their income initially, it is suggested to start with a lower percentage and gradually work towards the 20% target. Even a small amount can be a good starting point for building a solid foundation for future financial stability.
Also see: How to Set Short, Medium, and Long-Term Financial GoalsSPONSORED WISERADVISOR
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Example of budgeting with the 50-30-20 rule
Let’s consider a family of four – parents with two school-going children – who earn a combined monthly income of $8,000. They want to budget their finances more effectively to manage their expenses and achieve their financial goals.
Using the 50-30-20 budgeting rule, the family can allocate their income as follows:
1. 50% (or $4,000) towards their needs, including rent/mortgage payments, utilities, groceries, transportation, and insurance premiums. For instance, they can allocate $2000 for rent/mortgage, $500 for groceries, $500 for utilities, $400 for transportation, and $600 for insurance.
2. 30% (or $2,400) towards their wants, including entertainment, dining out, vacations, and other leisure activities. They can allocate $500 for dining out, $300 for entertainment, $1,000 for vacations, and $600 for other discretionary expenses.
3. 20% (or $1,600) towards their financial goals, including paying off debts and saving for the future. For instance, they can allocate $400 for paying off credit card debts and personal loans, $500 for emergency savings, and $700 for retirement savings.
By following the 50-30-20 rule, the family can manage their expenses more effectively while also making progress toward their financial goals. They can adjust their budget as needed, for instance, reducing their discretionary spending during lean months or increasing their savings allocation during high-income months. Also, by regularly tracking their expenses and reviewing their budget, the family can identify areas where they can improve further and optimize their spending.
Why tracking your progress through a budget is important
Regular budget monitoring can help you understand your financial standing and plan for the future. Overviewing your expenses can also help you identify areas where you may be overspending or where you can make adjustments to optimize your budget. For example, you may be spending more on dining out than anticipated, or your utility bills have been higher than expected. By identifying these trends, you can make informed decisions about where to cut back and how to allocate your funds more effectively.
However, it is important to remember major life events that may impact your financial situation. For example, a medical condition or job loss can significantly reduce your income, while the arrival of a new baby or an illness can increase your expenses. In such cases, it may take some time to readjust your budget to the 50-30-20 rule. This makes it essential to plan ahead and make necessary changes to your budget to ensure you are still meeting your financial goals.
Moreover, it is crucial to recognize that the 50-30-20 budgeting rule is not a one-size-fits-all solution. Depending on your unique circumstances and financial goals, you may need to adjust the rule to suit your needs better. For example, if you are aggressively saving for a down payment on a home or paying off debt, you may need to allocate more than 20% of your income to savings and debt repayment.
The key is to find a budgeting strategy that works for you and that you can stick to consistently over time.
Also, as budgeting becomes a habit over time, you can gradually reduce your tracking frequency to once every quarter or twice a year. You may also use budgeting apps that can make the whole process streamlined and more efficient.
The 50-30-20 budgeting rule may help you build wealth and achieve financial stability, especially if you are new to financial planning. By allocating 50% of your income to necessities, 30% to discretionary spending, and 20% to savings and investments, you can proactively meet your current needs and secure your future. This rule encourages discipline and helps you live within your means, and curb overspending and debt accumulation.
Use the free advisor match tool to match with experienced financial advisors who can help you understand the 50-30-20 rule. Answer a few questions based on your financial needs, and the match tool will help connect you with 1-3 financial advisors that may be suited to help you.
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