A Simple Budgeting Technique – 50/30/20 rule

June 20, 2022June 29, 2022 monfinance accounts, bank, budget, business, finance, loans, rules, services, simple, technique

Introduction

You’ve decided you need to start budgeting. Congratulations! You’re already taking a big step in the right direction. It’s a critical first step toward achieving your financial goals, like saving for retirement or building an emergency fund. But where do you start? For many of my clients, it’s helpful to walk through a simple budgeting technique that I often recommend for beginners. It categorizes income and spending into meaningful buckets so you can clearly see where your money is going and prioritize what matters most to you financially.

Create income tiers

Income tiers are a simple, effective way to help you manage your money. They allow you to divide your income into four different categories: Essential expenses, discretionary spending, savings/investments and emergencies. Use this template spreadsheet (or create your own) to track your income each month and then categorize it accordingly.

Pay yourself first

When you’re paying other people, like creditors or the electric company, are you also paying yourself? If not, start doing it today! Set up an automatic transfer from your bank account to a savings account every month. This way, you’ll have money available when the bills come due. You’ll also be able to take some of that money and spend it on things like clothes and fun activities with friends.

Create appropriate spending categories that are meaningful to you

The first step on the road to financial freedom is having a budget. A budget is a plan that helps you track and control your spending, saving, and investing. Without one, it’s impossible to know where your money goes or how much you have left at the end of each month. If this sounds like something worth doing, then let’s get started!

Reserve a portion of your income for major financial goals

It’s important to set aside money for major financial goals.

Saving for emergencies. If something unexpected happens, you’ll want to be prepared by having a cash reserve. You can do this by setting up an emergency fund in your bank account and transferring a certain amount of money (for example, 20%) into that account every month.
Saving for retirement. Your employer may offer a 401(k) plan or other type of retirement savings program, but you should still save as much as you can on your own by contributing to an IRA or other investment vehicle outside of work.
Saving for college expenses: The best way to save for college costs is by making regular contributions from each paycheck into a 529 college savings plan during the years when they aren’t needed immediately (such as high school). It’s also smart not only save money but also apply any scholarships or grants toward tuition expenses so that less debt needs paid back later!

A smart, easy approach to budgeting for beginners

A budget is simply a financial plan for the future. It helps you spend your money wisely, and it also keeps track of what you have left to spend. A good budget will help you feel in control of your finances and give you a sense of security that things are going well in the world of money.

Budgeting doesn’t have to be difficult! In fact, many people find that once they get started with a simple budget, they start enjoying their money more than ever before—and this can lead to better long-term financial health for the family or individual spending it.

A smart, easy approach for beginners:

Make sure that everyone has access to a clear record of income (like pay stubs) and expenses (like receipts). This way they’ll know exactly how much money came in during each month versus how much went out during each month; this information is crucial when creating any kind of budget because it helps determine how much should go into savings account(s), emergency funds etc).

What Is the 50/30/20 Rule?

The 50/30/20 rule is a simple budgeting framework that divides after-tax income into three major categories; 50% for essentials, 20% for savings and debt payments, and 30% for everything else, sometimes called your needs, wants, and savings.

Elizabeth Warren and her daughter popularized the 50/30/20 rule when they wrote about this simple budgeting method in their book.

Paychecks are then divided as follows:

50% for essentials include the mortgage payment, rent, other housing bills, groceries, etc.
20% for savings accounts, credit card payments, loan payments, and retirement contributions.
30% goes for things you want like nonessential items, including clothing, subscriptions, restaurants, etc.

Following this rule has helped many be able to save money at the end of each month. But this is a rule of thumb guideline, and circumstances will differ for each person. Depending on where a person lives can make it harder or easier to follow the 50/30/20 rule. If they live in a city with unusually high rent and where living is expensive, like San Francisco or New York, budgeting is harder to accomplish.

But even closely following the rule will help everyone see precisely where their paycheck is going each month. Because you can see where the money goes, it is easier to find ways to save money.

How To Use the 50/30/20 Rule Budget?

Using the 50/30/20 rule, calculate the monthly income or take-home pay. Look at the paycheck and see how much ends up in your bank account each payday. If you’re paid more than once per month, it might be easier to add it up and calculate for each month.

If the paycheck automatically deducts payments like pension funds, retirement funds, or health insurance, add those amounts to your take-home pay.

If you work for yourself, the after-tax income is what you earn each month, minus monthly expenses for business and money set aside for tax payments.

The next step is to figure out how much money to put into each category. There are only three major categories we need to figure out. Bank or credit card statements will show where you spent the money.

If you have several bank accounts or credit cards, you can use Personal Capital, free software which combines your cash flow, credit cards, bills, and bank account transactions in one place and makes it easy to manage. It automatically updates and classifies your financial data to know where you’re at financially.

Unlike other budgeting apps, Personal Capital doesn’t need you to do the tedious task of setting up a budget. After you link all your accounts together, it looks at your current spending and creates a budget for your lifestyle. You can then modify it as needed to suit the 50 30 20 rule. You can read my Personal Capital Review on how I use the various components and set up your free account.

Writing down your expenditures during the month will help you go through this process. Now split the expenses into one of the following three categories. The 50% category is for necessities such as:

Rent or mortgage
Basic groceries
Utilities like heating, electric, water, phone, and internet
Health insurance and car insurance
Minimum loan payments like car payments can go in this category instead of the 20% category
Other necessary expenses

The 30% category is for the things you want. It is not always easy to differentiate between wants and needs. A rule of thumb is wants are extras that are not essential to living or working. Some examples include:

Hobbies
Dining out
Subscriptions and cable TV
Concerts
Gym memberships

The 20% category is for savings and debt repayment. Every time you pay down credit card debt or other debt payments that carry interest, you save yourself money. If you’re paying 16% interest on a credit card, by paying it down, you are earning that 16% by not having to pay it in the future. Because of this, you should pay off credit cards with the highest interest rate first.

Since credit card debt is a very high-interest rate, it is best to pay it down as soon as possible. If you have been paying higher interest on credit cards, check out individual loan rates from around ten vetted lenders in 2 minutes on Credible to pay off your credit card debt.

Use the Personal Loan only to eliminate your higher interest rate debt and not take on additional debt.

The 20% category should include:

Savings account
Saving for a down payment
Building an emergency fund
Retirement contributions and other retirement savings so we have enough retirement income when we retire
A rainy day fund
College fund

Now you can see exactly how much needs to go into each category. Don’t worry if you don’t have enough income for a category since it can be tweaked for your after-tax income and wants and needs.

50/30/20 Budget Rule

An Example of the 50/30/20 Rule of Thumb

Calculate the monthly after-tax income or your take-home pay. For example, each month, you are paid $4,000. That is your after-tax income. If money is deducted from your take-home pay for health insurance, 401(k), a pension fund, or other retirement plans, add that amount to your after-tax income.

Let’s say you put in $500 per month to the retirement plan; then, your take-home pay is now $4,500 each month. Now we will calculate the amount of take-home pay that goes into each category according to the 50/30/20 rule. For the 50% essentials category, we multiply $4,500 by 0.5 and get $2,250.

For the 30% things you want category, we multiply $4,500 by 0.3, which equals $1,350. And for the savings and debt payment category, we multiply $4,500 by 0.2 for $900.

You already have accounted for the $500 that is put into a retirement fund, so the remaining $400 out of the remaining $900 is to lower credit card debt and other debts. According to the 50/30/20 rule of thumb, this is how a take-home pay of $4,500 would break down:

Necessities: $2,250 or $4,500 x 0.5
Wants: $1,350 or $4,500 x 0.3
Goals like savings goals and debt repayment: $900 or $4,500 x 0.2 minus the $500 already saved in a retirement fund

Please do not neglect the goals like 401(k) contributions because they will help you retire early.

Final Thoughts On the 50/30/20 Rule

The 50/30/20 rule is a monthly budgeting tool that divides your monthly income into three categories, needs, wants, and savings. The budget plan can help anyone understand where their weekly paycheck goes and help to control bad spending habits.

A monthly budget is the best way to handle your personal finance and make your financial lives more manageable. You can also use a budget for our financial protection by keeping us from getting into debt, which can happen before we know it.

Your monthly income only goes so far, and a budget helps you put the finances where it needs to go for necessary expenses, paying off existing debt, and could help you save more for other savings goals. If there is additional money after the categories are taken care of, extra payments can go towards paying off debt quicker or saving money.

You still have to track your spending to make sure you’re on track every month. If you set up the budget and then forget to track your spending, you won’t know if you’re on track every month.

None of us need a financial expert to tell us that the high cost of living makes it harder to meet a budget. But by seeing a budgeting plan in front of us, we might be able to stick to a budgeting plan easier.

Don’t be fooled by the simplicity of the 50/30/20 budget, assuming you can’t use it to build generational wealth. The savings can also include your goals to invest in stocks or real estate investing.

50/30/20 budget is a plan we can do without the help of financial experts or financial products. Instead of buying expensive financial planning industry software, we can use any spreadsheet program or paper and pen to make the 50/30/20 rule work.

50/30/20 Rule Frequently Asked Questions

As with most personal financial plans, there will always be questions. The better you understand your monthly budget, the easier it will be to follow it.

How Does Tithing Affect the 50/30/20 Rule?

The 50 30 20 rule of thumb is flexible. It is up to the individual to decide how they spend their earnings and how to classify them. With tithing or other religious donations, it is up to you to decide if this goes into a goal or want, or even a need category.

Does the 50/30/20 Rule include a 401(k) Plan?

Yes, the 50/30/20 rule includes 401(k) under the savings category. As explained in the example above, you would include the amount you put into a retirement fund like a 401(k) or pension plan in the take-home pay. And then subtract this amount from your 20% savings and debt repayment category since it has already been spent for retirement.

What Should I Do if I Don’t Have Enough Monthly After-Tax Income?

You are not alone in facing this situation, and it is a common question. With today’s high cost of rent and rising inflation, 50% isn’t enough for the necessity category. In this case, it would be best to take some from the 30% “wants” category and use it for the necessity category.
That leaves less income for the things we might want, like subscriptions or dining out, but the necessities need to come first. Find some expenses you can cut from the 30% “wants” category for the time being.
The next step should be improving your human capital to increase your income gradually.
Of course, most jobs are not conducive to increasing salary no matter how great you are at work. A better option is to then work on side gigs. It could be as involved as investing in real estate with little or no money down, using a partner to fix and flip houses, or wholesaling real estate.
If you want a more straightforward way to increase your income with a business, you could start a website.
Your website could be related to your day job. Or you could create one talking about your hobbies. Given the digital economy, no matter which path you pick, more and more of our world will be moving online. Automated tools make it easy to start a website in 10 minutes with zero computer programing skills. Here is my Hostinger affiliate link to get started with domain and hosting at a monthly cost of only $2.99.
All the above options are active income and need your time and energy. Another opportunity to get more money would be to consider passive income idea.

Why Does the 50/30/20 Rule of Thumb Generally Work for Monthly Income?

It works because it is a structured budget with no guesswork each payday. It lets you see exactly where your paycheck is going and helps cut down on wasteful spending.
A budget like this shows you the state of your financial health at any given moment. Budgets seem complicated, but this basic rule is not complex, and no one should need a certified financial planner to get a budget like this to work.

Is the 50/30/20 Rule the Ultimate Lifetime Money Plan?

As with any rule of thumb, they are not set in stone. But by adhering to the guidelines of the 50/30/20 rule, most people will be able to limit wasteful spending and set achievable financial goals.
There are various similar budgeting methods. The 80/20 rule states that a person takes 20% of their monthly income and puts that into a bank account. The other 80% will go towards all other monetary needs, including health care. The 20% rule forces a person to save or invest 20% of their take-home income.
Some prefer to use the 70/20/10 rule. For this rule, you divide your monthly after-tax income categories by 70% for all living expenses, 20% for debt payments, and the remaining 10% for savings. Whatever budgeting rule a person decides to follow is up to their individual circumstances.

Conclusion

Consider this your budgeting starter kit. These tips will help you gain a better understanding of how much money is coming in and going out, so you can make positive changes to your spending habits. The 50/30/20 rule is a great starting point for beginners because it’s easy to follow and understand, but should also be tailored to your personal situation. Keep in mind that it may take some time for these guidelines to feel natural, so try not to get discouraged if you slip up! Once again, I encourage all readers who are curious about their own finances or want more advice on budgeting to check out our website