This week we’re exploring the widely popular 50/20/30 rule. While it may sound like the next diet craze, it’s a lot easier than attempting a low-carb no sugar diet around Easter – now that’s brave!
Made popular by US Senator Elizabeth Warren and Amelia Warren Tyagi in their best-selling book, All Your Worth: The Ultimate Lifetime Money Plan, the 50/20/30 rule has become an all-star budgeting method. Its widespread success is mainly because it’s just plain easy to use.
It’s great for beginners, as it offers a framework to work within as you begin to tackle your personal finances and gain more knowledge about successful money management.
The 50/20/30 rule is easy enough to understand, it simply suggests dividing your after-tax income into needs, savings and wants.
Take a peak below to see what it’s all about and then give it a whirl!
Spend 50% of your income on needs (living expenses/essentials)
50% of your income should be going towards the true essentials of life such as food, shelter, utilities, healthcare and transportation costs. If you’re spending less than 50% on this category, it means you’ll have more money to contribute to the savings or flexible spending category.
There are some exceptions that go beyond basic needs that may fall into this category such as a minimum credit card or loan repayment that you’re obligated to pay. However, any extra money you’re putting towards these debts (beyond the minimum monthly payment) can go in the savings category.
Spend 20% of your income on savings
This should include any and all savings such as your emergency fund, vacation fund, shopping fund etc. This may include investments and any extra money you’re putting towards credit card and/or loan payments or your super (above the standard 9%).
Spend 30% of your income on wants (flexible spending)
This category is for wants, which can often times be hard to separate from your needs. Just try to remember that while your wants are nice to have, they aren’t necessary to keep you functioning. Needs on the other hand, like food, water, shelter, utilities and transportation are essential to making your world go around.
These may could include your cable bill, phone plan, dining out or takeaway coffee etc. They are generally things that make your life better, but are not essential to getting by.
Starting your 50/20/30 budget
Find out what your take home pay is at the moment (after tax has been taken out). Ideally 50% of this figure should be going towards living expenses and essentials.
Then to get a better handle on how you’re spending your income, you’ll need to start tracking your expenses. Once you’ve had a look, begin to split up your expenses into needs (essentials) vs. wants (flexible spending) so you can see what the split looks like right now.
You’ll also be able to see what portion of your income is going towards savings as well. Once you have an idea of what you’re spending and how they fit into each of the three categories, you can begin making some changes to get closer to the suggested 50/20/30 split.
However, don’t worry about fitting all of your expenses exactly into the 50/20/30 budget. As long as it’s relatively close, you’ll be in good shape!
Example budget
Meet Sally. She brings in $5,000 a month after taxes. That means $2,500 of her income can go towards her rent, food, gas, electricity and any minimum debt payment obligations she has. That leaves $1,000 for savings and $1,500 for flexible spending.
By splitting up her budget into living expenses, savings and flexible spending, Sally has a clear format to follow. She can see right away when she goes outside the parameters of her budget, making it easier to say no to unnecessary purchases.
Why you should try it
The 50/20/30 rule gives you a chance to reevaluate your budget in a different way. For instance, if you find out that your rent or mortgage alone is more than 50% of your living expenses, it may be time to reevaluate your living situation. You may want to consider renting in a more affordable area of town, or in the case of a mortgage, have a look at your refinancing options.
Or perhaps it may reveal that you’re spending much more on your wants than your needs, and it’s time to cut down on some unnecessary spending – it happens to the best of us!
Sometimes evaluating your finances from a different angle can give you a new perspective on what’s necessary and what’s just nice to have. Plus, the frame work is relatively simple to follow and allows for some flexibility, so you can make it work for your individual situation.