The best budget rule doesn’t have to be complicated or for you to spend a lot of time on it. The best budget rule is usually the easiest to follow. Take the 50/30/20 rule, for instance. The 50/30/20 rule is a simple monthly budgeting technique that outlines how much should go toward living expenses and savings each month.
With a clear big-picture summary of your monthly budget, you can reliably avoid overspending and progressively raise your savings without meticulously tracking every single transaction.
So what’s a budget?
A budget is a strategy for managing every dollar you have. It’s hardly magic, but it means more financial freedom and a less stressful life. Here’s how to make a budget and then manage it. You might want to try the 50/30/20 method. It’s one of the most effective budgeting strategies we’ve discovered, and here’s how it works.
What is the foundation of the 50/30/20 rule?
The 50/20/30 budget rule was made popular by U.S. Senator Elizabeth Warren in her book, All Your Worth: The Ultimate Lifetime Money Plan. According to this rule, you should spend 50% of your after-tax income on necessities, 30% on wants, and 20% on savings.
This simple and logical approach can assist you in creating the best budget rule that you can follow over time to achieve your financial objectives.
What exactly is the 50/30/20 rule?
The 50/30/20 rule is a simple and one of the best budget rule that can assist you in managing your money in an efficient, straightforward, and sustainable manner. The general rule of thumb is to allocate 50% of your monthly after-tax income to needs, 30% to wants, and 20% to savings or debt repayment.
You may put your money to work more effectively by consistently maintaining a balance between three key areas of spending. You can also save yourself the time and frustration of going into the specifics by choosing just three main categories to keep an eye on.
The 50/30/20 rule is an excellent approach to improving your spending patterns and resolving the age-old dilemma of being unable to save money. If you’re trying to pay off debt or put money aside for a rainy day, it can make it simpler for you to accomplish your financial objectives.
How to set up the best budget rule using the 50/30/20 rule
By splitting your after-tax income into just three areas for spending—needs, wants, and savings or debts—the 50/30/20 best budget rule makes budgeting easier.
Sticking to your budget and controlling your spending will be easier if you know exactly how much to spend in each category. An example of a budget that follows the 50/30/20 guideline is as follows:
Spend 50% of your money on needs
The expenses you definitely must pay and the goods you need to survive are considered needs. These include mortgage or rent payments; auto loans; food expenses; insurance; medical expenses; minimum debt payments; and utility bills.
You have to have these. The “needs” category excludes things that are seen as extras, such as Netflix, Starbucks, HBO, and eating out. You should only require half of your after-tax income to meet your requirements and commitments.
If you are spending more than that on your requirements, you will need to either reduce your wants or try to downsize your lifestyle, possibly to a smaller home or more modest vehicle. Carpooling, taking the bus, or preparing meals at home more frequently might be solutions.
Spend 30% of your income on wants
All the items you purchase that are not absolutely necessary are considered wants. This includes going out to eat and seeing a movie; that new handbag; athletic event tickets; trips; the newest electronic device; and ultra-high-speed Internet.
If you boil it down, everything in the “wants” category is optional. Instead of visiting a gym, you can work out at home, prepare meals at home, or watch sports on television rather than purchasing tickets to an event.
This category also includes the decisions you make when upgrading, such as choosing a more expensive steak over a cheaper hamburger, purchasing a Mercedes over a Honda, or deciding between viewing TV for free with an antenna or paying for cable. Wants are essential for all the little extras you buy to improve your quality of life.
Put aside 20% of your income as savings
Lastly, make an effort to set aside 20% of your net income for investments and savings. This includes making IRA contributions to a mutual fund account, investing in the stock market, and adding money to an emergency fund in a bank savings account.
In case you lose your job or experience an unexpected incident, you should have at least three months’ worth of emergency savings on hand. After that, concentrate on retiring and achieving future financial objectives.
Repaying debt is another use for savings. While the minimum payments fall under the “needs” category, any additional payments save money because they lower the principal and accrued interest.
A step-by-step guide to using the 50/30/20 rule
So, how exactly do you apply the 50/30/20 rule? To apply this basic budgeting method, compute the 50/30/20 ratio depending on your income and categorize your spending. Here’s how it’s done:
Calculate your income after taxes
To use the 50/30/20 best budget rule, figure out your after-tax income first. Your monthly income as a freelancer, less your business expenses and the amount you’ve set up for taxes, will be your after-tax income.
This will be simpler if you have a consistent job and a paycheck. See how much money is deposited into your bank account each month by looking at your payslip. If payments for pension funds or health insurance are automatically taken out of your salary, add them back in.
Sort the last month’s purchases into categories
You must examine how and where you spent your revenue during the previous month in order to acquire a complete picture of where your money is spent each month. Take a look at a copy of your 30-day bank statement, or just use the Insights function on your N26 app.
Various subcategories, like salary, food, entertainment, and more, are automatically created from all of your transactions. Divide all of your spendings into the following three groups: needs, wants, and savings. Keep in mind that a need is a cost you absolutely must have, like rent.
A want is an extra luxury that you could do without, like going out to eat. Savings include extra debt payments, pension fund contributions in retirement, and money set aside for emergencies.
Review and modify your spending to adhere to the 50/30/20 rule
Once you know how much of your income goes toward needs, wants, and save each month, you can start to adjust your budget such that it follows the 50/30/20 best budget rule. By calculating how much money you spend each month on wants, you may do this in the simplest way possible.
A want is not extravagant, according to the 50/30/20 best budget rule; rather, it is a fundamental nicety that enables you to enjoy life.
It’s better to figure out which of your wants you can cut down on to keep within 30% of your take-home pay because cutting back on your needs might be a difficult and complex undertaking. Your chances of reaching your 20% savings goal increase as you cut back on your wants-related spending.
The significance of saving
The nation has exceptionally high levels of debt, and Americans are notoriously terrible at saving money. Americans owe $14.9 trillion in total, including $756 billion in credit card debt, as of the third quarter of 2020. The personal savings rate was 6.4% in January 2022.
The 50-20-30 rule is designed to assist people in managing their after-tax income, primarily so that they have money set aside for emergencies and retirement savings.
Establishing an emergency fund should be a top priority for every household in case of job losses, unanticipated medical costs, or any other unforeseen financial costs. If a household uses its emergency money, it should concentrate on replacing it.
As people live longer, saving for retirement is also a crucial step. The key to a comfortable retirement is to estimate how much money you’ll need in retirement and start saving early.
Saving is challenging, and life frequently presents us with unforeseen costs. Individuals should have a plan for how they should manage their after-tax income by adhering to the 50-20-30 best budget rule.
If they discover that they spend more than 20% of their income On wants, they can identify strategies to lower those costs so that money can be allocated to more crucial areas, such as retirement and emergency funds.
Although it is not advised to live very simply or strictly, with no luxuries, life should be enjoyed. Having a plan and following it will enable you to pay for your expenses and save for retirement, while also engaging in the activities that bring you joy.