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Colin Dodds is a writer, editor and filmmaker who has worked with some of the biggest companies in media, technology and finance, including Morgan Stanley, Charles Schwab and Bank of America.
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Doug is a Certified Alternative Investment Analyst who spent over 20 years as a derivatives market maker and asset manager before “reincarnating” a decade ago as a financial media professional.
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Prior to joining, Doug spent nearly six years managing content marketing projects for dozens of clients, including The Ticker Tape, market reports from TD Ameritrade, and a financial education site for retail investors. He has held a CAIA license since 2006 and held a Series 3 license during his years as a derivatives specialist.
Doug previously served as Regional Director for the Chicago Region of PRMIA, the International Association of Professional Risk Managers, as well as Editor of Intelligent Risk, the quarterly newsletter for PRMIA members. He holds a BA from the University of Illinois at Urbana-Champaign and an MBA from the Illinois Institute of Technology, Stewart School of Business.
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The 50-30-20 rule is a popular way of dividing up spending categories in your personal or household budget. The goal of the rule is for 50% of your after-tax income to go to the basics, 30% to things you don’t need – but to make life a little nicer – and the last 20% to pay down debt and/or increase savings.
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The 50-30-20 rule isn’t meant to be an exact budget law, but rather a general guideline to help you think about how to split those paychecks.
Creating a monthly budget is the first step in directing your income toward your short, medium, and long-term goals, and the 50-30-20 rule is the first step in budgeting.
Start with your monthly after-tax income based on your most recent paychecks. This is the pie you break down for your 50-30-20 budget.
Once you know your income, look at your bills: rent or mortgage, car payments, gas, electric and phone bills. Then estimate how much you spend on groceries each month. These are your most essential needs. Add it all up, and if it’s half your salary or less, you’re well on your way to a 50-20 budget.
If it’s more than half of your income, ask yourself where you can cut back. Do you need this car for your business or is it just for weekend cruises? How much will you pay to turn it off? Don’t mind your budget when shopping? And some of those drinks you’re drinking probably fall into the next category.
Assuming your necessities take up half of your after-tax income, it’s time to look at how you spend the rest. Bank and credit card statements can help you figure out how much you spend on entertainment (including cable and streaming services), dining, travel, shopping, and self-care. Look back in a few months to get an idea of the average amount you spend and how it compares to your income. If it’s more than 30%, go through the list to see what fun you’ll miss the least and then make some cuts for the coming months.
The last 20%—paying off debt and saving—requires some discipline. It’s tempting, especially if you’re just starting out, to put off saving and limit your debt payments to the minimum required each month. But keep in mind: Credit cards and student debt usually have high interest rates. High interest can be a major obstacle to achieving your financial goals.
If your debt is manageable and 20% is set aside for savings, think about what you’re saving for. Many experts recommend saving six months of expenses in an easily accessible emergency fund, usually a savings account. But if you’re saving for long-term goals like retirement, you may want to consider an Individual Retirement Account (IRA). If your employer offers a 401(k) plan, contribute as much as possible, especially if it matches a portion of your contributions.
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After taxes, Ben earns $4,000 per month. If he keeps a 50-30-20 budget, his monthly expenses might look like this:
When you’re just starting out, it can be impossible to achieve these numbers in the short term. For example, a modest apartment in a big city can easily eat up 50% of the entry salary. And in the future, life changes—such as the birth of a child or a career change—may interrupt your 50-30-20 targeting.
It is a standard, not a hard and fast mandate. If you do suffer a setback, make sure you get back to 50-30-20 as soon as possible.
By the same token, when the budget is a little tight, feel free to kick the savings rate above 20%. One day your future will thank you. The 50/30/20 budgeting rule is a simple way to help you manage your money more effectively. This rule of thumb is to divide your after-tax income into three spending categories – 50% for needs, 30% for wants, and 20% for savings. This is not a hard and fast rule, but simple guidelines to help you build a financially strong budget.
How To Follow The 50/30/20 Rule
This rule helps keep your spending in balance between your main spending areas and allows you to work more efficiently with your money. With only three main categories, you can also save yourself the time and stress of understanding the details every time you go. In other words, it helps build a structured spending habit. It also helps you achieve your financial goals by saving more.
United States Senator Elizabeth Warren wrote a book in 2005 called All You Deserve: The Ultimate Financial Plan for a Lifetime. This book concludes that you don’t need a complicated budget to control your finances. Instead, use this rule to balance your finances across needs, wants, and savings.
Necessities are basic expenses that you absolutely need for your life. Basic requirements for food, shelter and clothing fall into this category. So your needs dominate the spending bucket and you can’t live without them. Some of these expenses include the following –
Under this rule, half of your after-tax income is used to achieve a basic standard of living with all liabilities to take care of. That is why they are always on the urgent money list. If you don’t make these payments, you’re likely to get into trouble or collect more obligations next month, which will include additional late payment fees.
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This section does not include costs for cable TV, Netflix, dining, lifestyle or entertainment. There is a possibility that you will spend more than 50% of your after tax income on your needs. Although it is undesirable, you can limit your luxury. Basically, you need to look for ways to increase your income or look for alternatives to reduce your current lifestyle.
This is the second component of the budget base. These are not essential expenses of survival, but the luxuries of life. In other words, you can do without these articles however much you want to have them. It includes all expenses that make your life more comfortable. Some of these expenses include the following –
This list never ends. You can always look at the organization of these expenses. Most of the necessities are expensive and require a lot of money. But there are also cheaper alternatives. For example, buying a traditional watch instead of a luxury one, and buying a hatchback instead of an SUV.
Sometimes you are also tempted to buy expensive things to satisfy your cravings. You can purchase these items on free EMI charts or no processing fee charts. However, nothing in this world is free. There are always some hidden fees that are not shown to us.
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So, if you feel like you’re spending more than 30% of your income on cravings, you might want to look into reducing those expenses. However, this rule does not require you to stop enjoying life by giving up the things that bring you joy. But it is a tool that allows you to track and control your spending habits.
This is the last and most important component of the budget rule that facilitates financial planning. This money helps meet your future needs. It ensures that these savings will help you enjoy the same lifestyle you currently live. This part of the funds can be used for
You should always aim to grow your savings over time and make sure you’re accumulating funds to meet your financial goals. This part of the savings must also be properly planned. You can start with a certain amount of emergency funds for unfortunate events such as a health or personal crisis. After your emergency funds are ready, you can put your money into different investment plans. However, you need to ensure that these investment plans can provide inflationary returns over time and allow you to access your funds at any time.
Here’s an example of understanding the 50/30/20 budgeting rule. If Mr. Akash earns INR 40,000 per month, his monthly expenses may look something like this
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