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For many people, the word budget is synonymous with cutting back on what you spend, particularly when it comes to frivolous items. But budgeting is about more than controlling your spending. It’s a method of allocating your money in a way that helps you reach your financial goals.
Budgeting does not have to be a complicated process. In fact, most people would benefit from a simple solution that helps them easily determine how much they should be spending and saving each month. Enter the 50/20/30 rule, which can help you follow a budget using straightforward proportions. This rule provides broad guidelines to help you get started on budgeting, which can then be customized once you have the system down pat.
This rule is particularly helpful for young adults just starting out after college or high school. When you receive your first “real” paycheck, it can be difficult to know exactly what to do with it. The 50/20/30 rule makes it relatively easy to figure out how to reach savings goals, by dividing your monthly salary into three categories: essentials, savings and personal. By sticking as closely as possible to these categories, you will be better able to achieve to secure your financial future.
The first category is the biggest and perhaps the most important. Each month, you should set aside half of your salary for your essentials, which includes everything from housing to food and transportation. The important thing here is to stick to 50 percent of your income. Going over this amount can throw the entire system out of alignment.
Once you have determined what 50 percent of your income is, the next step is making sure that your essentials are covered by this amount. This can be challenging in areas of the country where housing costs are high, such as New York City or San Francisco. If you live in one of these areas, you may need to adjust your other spending on essentials to make up for outsized housing costs. For example, if half of your monthly income is $3,000 and your rent costs $2,000, then that leaves $1,000 per month for your other expenses. That probably does not leave room for a car payment, so consider using public transportation or walking instead. Or lower your food costs by taking advantage of low cost food options, such as buying in bulk or preparing most of your food at home rather than eating out. Some items, like utility bills, are fixed expenses. But you can still trim costs by doing things like getting rid of cable in favor of internet-based television options, or using energy and water efficiently.
Staying within this 50 percent guideline is critical to balancing the remainder of your budget. While it may be challenging based on your unique living situation, work hard to find ways to save money on essentials so you can fit squarely within half of your monthly income. Doing this will make it far easier to meet the next budgetary goal: 20 percent to savings.
The next step in the budgeting process is to devote 20 percent of your monthly income to savings. The term savings is used broadly here, and can mean a number of different items, from paying down debt to adding to your retirement fund or building a rainy day savings account. Hitting this figure each month will help you reach your goals more quickly, from getting out of debt to accumulating a nest egg.
This budget category is incredibly important for your longterm financial well-being. Putting aside money in your 20’s (or at any age) can mean a more secure retirement, and it can prevent financial ruin if the unexpected should happen. But savings can only happen once the essentials have been paid for — and before any personal spending occurs. If you can, devote more than 20 percent each month to savings — you’ll find yourself in much better shape financially if you save even a small amount over 20 percent each month. This is particularly true when it comes to retirement savings. While most young adults view retirement as something far off in the future, it comes sooner than you might expect. And thanks to compounding interest, the more you save in your 20’s, the more you will have for your retirement in your 60’s or beyond.
The last category of spending is something that many people tend to put above savings. Under the 50/20/30 rule, up to 30 percent of your monthly income can be devoted to personal expenses that are not essential to your basic living needs.
Personal expenses encompass a wide variety of spending, from cell phones to new clothes to vacations and new clothes. What is personal and what is essential depends on each person. For some, a gym membership falls into the category of essential, while for others, a gym membership is a luxury but a cell phone is an essential. However, you categorize these expenses, remember to keep them at or below 30 percent of your total monthly income. By limiting personal expenses in this way, you can make sure that your essentials are covered and your savings continue to grow.
Putting the 50/20/20 Rule to Work
The beauty of the 50/20/30 rule lies in its simplicity. Anyone with a calculator can figure out these basic percentages, and from there, can determine how to adjust their spending on essentials and personal items to ensure that they can hit the goal of saving at least 20 percent of their monthly income.
While the details of each person’s budget will vary based on their income and expenses, this rule provides both structure and flexibility to help you reach your goals. The rule does not require a high salary; it only requires a willingness to put in a little bit of time and effort to make sure that your spending habits are not destroying your ability to pay down debt or add to savings. The same percentages apply whether you are making $100,000 or $25,000. It’s just a matter of figuring out the numbers for each category and sticking to the budget.
Of course, with any budgeting rule, common sense must prevail. The 50/20/30 rule provides a framework, but there will be times when the percentages must yield. There may be a time when something that may seem like a luxury, like an airplane ticket, becomes a necessity, such as if a family member is ill. Other times, life situations may crop up that require you to deviate from your budget. There are also people for whom strict adherence to the percentages simply will not work due to the demands of their life. Create a budget that works for you, based on your current needs. In the future, if your life has changed, you can always return to the 50/20/30 rule.
Budgeting can seem like an overwhelming process, but with the 50/20/30 rule, it can be relatively simple and painless. With a wide variety of online budgeting tools available today, budgeting is easier than ever. Take advantage of these tools and put the 50/20/30 rule to work for you today. It will help you pay off debt, increase savings, plan for retirement and weather any financial emergencies successfully.
Author: Jeff Gitlen, CEPF®