It can be easy to get a bit lost when it comes to money and budgeting. How do you know if you’re on track? Are you making the right decisions? How much should you be saving each month?
For questions like these, I think it’s helpful to compare yourself to some general rules of thumb.
The 50/30/20 budgeting rule of thumb is a helpful measuring stick to get a sense of where you currently stand with your money and where you can focus on changes to your monthly spending.
Of course, a rule of thumb is only a guideline. Personal finance is personal. We’re all very different. So only use rules of thumb like this one as a guide, not an absolute rule.
Ok, so what is the 50/30/20 budgeting guide?
It says that if you total up your monthly after-tax take-home pay…
- 50% should be spent on Needs like housing, food, and transportation.
- 30% should be spent on Wants like shopping, eating out, and entertainment.
- 20% should be saved, used to pay down debt and invest in retirement.
Figuring out how your current spending compares to this 50/30/20 guideline is a helpful exercise to understand opportunities to adjust your monthly spending.
It helps guide you on where you should try and cut back on spending and where you may have room to save or invest more money each month.
For example, if you’re spending 70% of your take-home pay on rent, you may want to consider moving or getting a roommate.
If you’re only saving 5% of your monthly take-home pay, you may want to try and cut down on some entertainment spending to boost your monthly savings higher.
Here’s a step-by-step guide to figuring out your own 50/30/20 guide.
Step 1 – What is your monthly after-tax take-home pay per paycheck?
Take a look at your most recent pay-stub. Get the total that was deposited into your checking account and then add to it any money that is automatically taken out of your paycheck for retirement or 401k savings each paycheck.
You want to get the total amount of money you earned each month after taxes and that includes 401k retirement savings.
This is your take-home after-tax income per paycheck.
Step 2 – What’s your monthly after-tax take-home income?
How often do you get paid?
If you get paid every 2 weeks, multiply your total from step 1 by 26. If you get paid twice a month say on the 15th and 30th, then multiple your step 1 total by 24.
This is your monthly after-tax income.
Step 3 – What is your Needs Spending Total?
Take your total from Step 2 and divide by 2.
This is your Monthly Needs Budget. it’s 50% of your monthly take-home pay.
Needs include your mortgage or rent payment. Your car payment and gas spending. It also includes your grocery bill each month. It is intended to cover “required” spending.
- Rent / Mortgage Payment
- Car Payment
- Monthly Utility Bills (Gas, Electric… etc)
- Phone Bill
- Grocery / Basic Food Spending
Total up how much you spent in these areas last month. This is your current spending on Needs.
Step 4 – What is your Wants Spending Total?
Take your monthly income total from Step 2 and multiply it by 0.30.
This is your Monthly Wants Budget. It’s 30% of your monthly take-home pay.
Wants are your discretionary spending each month. It’s fun money, Netflix or Cable bill, shopping money, trips to Starbucks and nights out on the town.
Total up how much you spent in these areas last month. This is your current spending on Wants.
Step 5 – How much should you be saving each month?
Take your monthly income total from Step 2 and multiply it by 0.20.
This is your Monthly Savings and Debt Payment Total.
This includes money you save for retirement, any student loans or other debt payments as well as general savings and investing.
Total up how much you saved, paid toward debt or added to your retirement savings last month. This is your current monthly savings total.
How do you measure up?
What do you think? Remember, the 50/30/20 rule of thumb is just a guide. It’s not science. It’s not an absolute rule.
All of us will have different circumstances. However, it is a helpful guide to measure against and reconsider your budget if you’re way off in any one area.
Have you made a spending plan? Now that you have your aftertax income breakdown, take a few moments to figure out what budget works for you. Here at Tip Yourself we call it a Spending Plan, because let’s be honest spending money is much more fun than budgeting money.
How did you measure up? Do you think the 50/30/20 rule is a good guide? Let me know below, post a comment.