There are so many different budgeting methods to try. There is the cash only method, zero-sum method, and even the 50/20/30 rule. If you are just starting to create a budget, then the 50/20/30 rule is a great place to start. Instead of thinking of all categories which your spending and savings go to, allocate your after-tax income three main categories. Those three main categories are:
- essential expenses
- financial priorities
- lifestyle choices
The 50/20/30 budgeting rule is especially good for recent college grads or those that have never had a budget before for a few reasons. Many recent college grads are determining what they can afford in terms of housing and a vehicle (if necessary). When you aren’t sure of how much rent you can afford, the 50/20/30 budgeting rule will give you a rough estimate.
Now, let’s dive deeper into those three main categories that are used when setting the 50/20/30 rule.
Essential Expenses: 50%
The first category is essential expenses. No more than 50% of your income should go to essential expenses which are things that you can not live without. By things that you can not live without, I don’t mean your expensive manicure habit or habit of eating out for lunch every day. The essential expenses category includes housing, transportation, utilities, and groceries.
The is especially important when getting your first apartment or determining how much you can afford to pay for your mortgage. For example, if your total take home pay is $3000, then you want to make sure that your essential expenses are no more than 50% of that or $1500. Therefore, ensure that your housing, transportation, utilities are less than that amount.
Depending on the cost of living in your city and your financial goals, you may need to get a roommate in order to lower your housing costs. Personally, I had a roommate a few years ago in order to save additional money for a down payment on my home which would be considered a financial priority.
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Financial Priorities: 20%
The second category is financial priorities. Financial priorities are things necessary to build a strong financial foundation. These include saving for retirement or an emergency fund and paying down a credit card or student loan debt. Financial Priorities can vary between people. Saving for a big vacation or a down payment on a home could also go in this category.
If we are using the same example from earlier and your take home pay is $3000, then you want to make sure at least $600 is going toward financial priorities. If you have student loans, then you may have a set monthly payment when would come out of this category. If you have credit card debt, then your monthly minimum amount would come out of this category as well. As long as you have additional money left over, then you can pay additional amounts on your credit card bill and add money to your savings account.
Lifestyle Choices: 30%
Lifestyle choices are pretty much everything else or voluntary activities and fees that you choose to spend from your discretionary income. That Netflix account, eating out, cable, shopping, personal care, and other habits all fit into this category.
I know, I know. Somethings like those regular waxing sessions or Sunday Funday brunch should be essential. This is where budgeting truly comes into play. If only 30% of your take home pay is going into lifestyle choices, it is important to figure out which lifestyle choices are more important than others and ways to cut back. That weekly trip to the nail salon may end up being biweekly or monthly depending on your budget.
Using our earlier example, if you make $3000 after tax then $900 would go towards lifestyle choices. I like how this category is titled because ultimately it comes down to choices. You may not be able to do everything you want to do in terms of entertainment, but you can narrow down your priorities and choose to spend the money allocated to those lifestyle choices in this category.
The 50/20/30 proportions are just a skeleton to begin setting up a budget. Your specific situation may throw those percentages out of whack. For example, if you have a student loan payment which is 20% of your take home pay, that doesn’t mean you should forego saving for retirement. At that point, it would be important to make some adjustments and cut back on things in the lifestyle choices section.
On the flip side, what if your essential expenses don’t add up to 50% of your take home pay? That would be a great opportunity to increase your financial priorities. Saving more for retirement now will give you the benefit of compound interest so that you will have a larger nest egg later in life.
The 50/20/30 rule isn’t the only budgeting method. You could also budget like a pro.
Do you have a budget? If so, what do you follow? If not, do you think the 50/20/30 rule would be a good place to start?
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