Do you want an easy way to allocate the money you take home every month? Have you heard of the 50/30/20 rule?
Well, instead of drawing up a complicated spreadsheet of all the items you spend each month, which is not a bad idea if you have the time and patience, use this 50/30/20 rule to gauge your spending.
So what is the 50/30/20 rule all about. It’s simple:
Your Fixed Costs – 50%
- Determine what your fixed costs are? Fixed costs are your essential monthly payments like your Netflix subscriptions, gym subscriptions, car and mortgage payments and your subway pass which you have no choice but to make if you want to keep things going.
- Keep fixed costs strictly to no more than 50% of your take-home pay.
- Make a list of what your fixed costs are (Oops we did say no complicated spreadsheets, but bear with us). Do you really need a subscription to more than two glossy magazines? Can you live with a simpler mobile plan? Hunt around for cheaper alternatives if some of these subscriptions are must-haves.
- The point here is to trim away some of your fixed costs so that your pay-check is automatically inflated to absorb the most important stuff, like your rent, mortgage payment and car payments. Remember, default in payment of any of these important fixed costs will have far reaching implications and may sometimes cost you your job.
- The point in trimming the fixed costs is then to re-allocate the excess of the savings to what is the most important aspect of your monthly budget – feeding your financial goals, which we’ll get to after we account for your discretionary spending.
- And look, the best budget is one that you can stick to. So don’t make the budgeting mistake that almost everyone does. Which is cutting out every little thing that you don’t technically need, a glass of wine, going out with friends, or making payments to a charitable organization. These things help you enjoy your life, let’s just account for them so we can trim then down to fit our budgets.
Your Discretionary Spending – 30%
- This portion of your budget is, of course, where we really want to get down to because it’s what we live on. It allows us to go for that Friday night drinks after a long work-week; it allows us to go away with that someone special for a long weekend and allows us to pop into that shop where we’ve been eyeing something in the window display for some time.
- We include food in this category of your budget because while food is like a fixed cost, how much you actually spend can vary, and you can certainly learn how to shop smart and learn how to cook a few of your favorite dishes at home rather than head out to the restaurant.
- One tip we have is to always pay your fixed costs and the financial goal portion of your budget first so that even if what’s left isn’t really 30% of your take-home, hey, this way, you’ll feel a sense of freedom that whatever you spend that month is what you can truly afford.
- A lot of people equate financial freedom with having a lot of money to do whatever they want. Yes – true – that’s one part of financial freedom. Knowing that what you spend is what you can really afford without busting that credit card limit or eating into fixed costs like rent and car payments and mortgage payment!
- Yet true financial freedom is only achieved when planned for. You need to set your financial goals in advance and budget for them using this 50/30/20 method.
Your Financial Goal – 20%
- This area of your budget is where you want to put money aside for paying down that credit card you bust the limit of last summer on a holiday to Italy or Spain.
- This area is also where you want to put some money aside towards a fund, like your 401(K), or towards a private fund where you can then invest in safe income-generating products. If you’ve been thinking about buying a house or starting that small business, this is also where the 20% portion would provide you with the cash you require when the time comes.
- Any pool or funds built up will also act as your emergency funds for those unexpected times.
- We recommend that you set up an automatic payment from your bank account to another bank account for this crucial 20% of your take-home pay. That way you don’t miss a payment and it’s out of your usual bank account before you are tempted to make a larger than usual purchase.
- We also recommend you limit your credit card limit to about 1/3 of your take-home pay. This acts as an automatic barrier to over-spending.
My dad used to say to me that if you spent more than 30% of your take-home pay on rent, then you’re paying too much. These rule-of-thumb guides are also useful when you draw up your 50/30/20 budget as it can help you gauge where you can make a little more room in the 50% portion of your plan. Sometimes, an apartment or a room a little less central can be a more comfortable and nicer living space than insisting on being in the thick of things downtown.
Also, some debts are good debts. Debts like a reasonable fixed-rate mortgage is a good debt, as you don’t really want to pay the mortgage down so quickly as there are other higher-yield places to invest your money. Once you pay down the good reasonable fixed-rate mortgage you were lucky enough to sign on to, you may not be able to get another one on the same terms.