With so many finance blogs and tips on ways to make extra money online, we rarely see tips on how to budget properly. However, there is one budget rule that has been great gaining a lot of popularity in recent years. This rule is known as the 50/30/20 rule.
What is the 50/30/20 rule?
50/30/20 rule is based on an individual's needs, wants, and savings. It states that one should divide their net income (the income that one gets after taxes) in the following manner: 50% should go towards one's needs, 30% should go towards their wants, and 20% should go towards their savings. This rule was popularized by United States Senator Elizabeth Warren. It helps individuals better track their money and understand it how to prioritize their finances. It also helps people who are not financially secure and who don't have a clear-cut method for dividing their spending.
Why 50% needs?
Because needs are things that you cannot live without, the largest portion of your money will go towards then. After all, your needs are what ensures your survival. This category includes (but is not limited to) things like:
- Rent
- Hydro
- Mortgage payments
- Car payments
- Gas
- Groceries
- Credit card minimum payments
- Phone bill
Half of your income after taxes should go towards these needs. If you find that you are spending more than 50% of your salary after taxes on necessities, then you should think of cutting down costs. You can do this by getting a lower cell phone bill, taking public transportation, or even moving. It's important that you try downgrading your lifestyle until your necessities reach 50% or less of your income after taxes. The same goes for whether or not you're living with a partner. If the sum of your necessities is greater than the sum of half of your incomes after taxes, you should both consider cutting costs.
Why 30% wants?
The second greatest category in the 50/30/20 budget rule is your wants. 30% of your income after taxes should go towards these wants. This category can include (but is not limited to) things like:
- Takeout
- Shopping
- Restaurants
- Entertainment
- Subscriptions like Netflix or Apple TV
- Hobbies
- Vacations
You may feel like 30% of your net income is a lot to be spending on your wants, but you’re actually likely already spending more than that on them. It's recommended that you go through your credit card statements and tally up exactly how much you've spent the last month. And if you find out that you're spending more than 30% on this category, try to see where you can cut costs – maybe you're still paying for a subscription that you no longer really use, or maybe you are spending more on takeout and delivery services than you thought.
Why 20% savings?
According to Equifax Canada, average Canadian has almost $21,000 of consumer debts. Although this is a drop from previous years, it's still a pretty significant number. Unfortunately for those that do possess a lot of debts, it can be difficult to set money aside towards savings. For those individuals, the 20% in the 50/30/20 budget rental should be accorded to their debts. This means that if your monthly net income is $4000, you should set $400 towards your debts until they are paid off. Once your debts are paid off, that $400 should go towards your savings. It's important to have an emergency savings fund should unexpected expenses arise (like car repairs, plumbing, or medical expenses). If you do not have an emergency savings fund, you will likely just be putting yourself more into debt.
But savings should only be about emergency funds. It's good practice to save money for your future — more specifically, for your retirement. Although you may still be young, the earlier you start saving for retirement, the better. This is especially true for those that plan on retiring early. Consider getting yourself a TSFA account or an RRSP account.
How to apply the 50/30/20 rule
The 50/30/20 budget rule is a great way for those that aren't good at keeping track of their money to have some structure. Although the calculations may seem a little complicated and frustrating to do every time you receive a paycheck, it's not as complicated as you may think and the benefits are worth it.
The first thing you should do is to figure out how much your net income is. It's only once you do that that you'll know exactly how much you need to allocate to each category. The second thing you should do is to calculate all of your monthly expenses – your needs. If, after calculating how much you should allocate to your needs, you find that your expenses exceed that number, it's worth looking into making changes. Next, and you should look up your last monthly credit card statement and see how much you've spent on your wants. Again, if that number exceeds how much she should be allocating to that category, try to see if you can cut costs. This can include cancelling certain subscriptions that you no longer use or setting a limit on how often do you use delivery services on a monthly basis. The rest (20%) will either go towards your debts or your savings.
If you realize that you are spending more than 20% of your net income on your debts, and are having trouble making all of your monthly payments, fill out Allevia's budgeting questionnaire. It will analyze your financial situation and will help you find the best solution. Allevia's only goal is for you to read yourself of your financial burdens so that you can lead the life you've always dreamt of living.
