Having a plan for your money is central to building a solid financial foundation and the 50-30-20 rule can help. Use it as a starting point to put your expenses into “buckets” so you can take control, plan your spending and progress towards your financial goals.
The rule suggests designating your dollars into three main categories: needs, wants, and savings. The goal is to limit fixed expenses (or needs) to 50% and discretionary expenses (or wants) to 30% of your net (after-tax) income, leaving 20% to save for goals.
50% to “needs”
One part of this rule that is often debated is what constitutes a “need” vs. a “want”? Let’s take the purchase of a vehicle as an example. How much you spend on a car can vary widely. Depending on your circumstances, having a vehicle may be a legitimate need. You may need a car to get to work and earn money to pay bills. But do you need a luxury car or would something less expensive work?
Similarly, we all need food and clothing to live. However, spending on these two categories can very easily bleed over into wants depending on your choices. If your needs far exceed 50%, it may be time to think about making some changes.
Be honest with yourself about whether the things you’re putting in this category are vital to your life or if you could classify, at least part of, the expense as a want. Another way to think of it is as a tradeoff — it’s OK to spend more on housing if having a more expensive place is important to you; it just means you might need to spend less on a car to balance things out.
30% to “wants”
- Entertainment, including cable
- Dining out
- Gym membership
- Personal care beyond the basics
- Cell phone beyond the basic plan
As you can see, the rules can be a little complicated. Most of us need regular haircuts to maintain our routine appearance. However, spending on a pricey salon cut may go beyond need and belong in the wants category. And if your wants are way beyond 30%, you may want to consider scaling back and contributing more to saving for more long-term goals.
20% to “goals”
The nice thing about the goals category is that it’s all about you. You get to decide what you want to do with the money. Do you want to travel the world? Retire early? Help your children pay for college? Once your essential needs are taken care of, you can prioritize your other funds according to how fast you want to achieve your goals.
If one of your goals is to pay off debt, you can plan for extra payments from this category to speed things up. However, you should never include regular debt payments in the goals category. Instead, monthly credit card minimums and loan payments belong in the needs section because, until you’ve eliminated them, you need to pay them each month.
If, after spending on needs and wants, you don’t have 20% leftover, you may want to consider making some adjustments to create more room for goals.
Tying it all together
The 50-30-20 rule can help you allocate your money to needs, wants and savings and offer insights into where you may need to cut back. Remember, this rule is really a guideline, particularly when you’re just getting started. Use it to help you on your journey to financial success.