Between a busy work and personal life, it’s hard to find the time or willpower to start crunching numbers into a complicated budgeting plan for your life. Well, great news! 50/30/20 is a well established rule that will simplify everything so you can master money and achieve your financial goals.
What is the 50/30/20 rule?
The 50/30/20 rule is a money management method that splits your spending budget across 3 areas so that you can enjoy a healthy life balance and save money without overspending.
The 50/30/20 rule states that you should allocate your monthly income spend to the following categories:
- 50% on needs
- 30% on wants
- 20% on savings or debt payment
And that’s it. But what’s the difference between each one? This is essential to know for you to apply the rule properly. So, let’s break them down using examples.
Spend 50% on needs
When it comes to budgeting, your first priority is to cover your needs. These would be your essential living costs such as rent and energy bills. The things that are necessary to live and function (no, not coffee). You should be as strict as possible to meet your needs on 50% of salary. Consider your monthly income post-tax aka how much is paid into your bank by yourself or employer (add anything like pension contributions to the total amount), then half it. So someone on £30,000 with a student loan repayment may get £1,997, which only leaves them with £998.5 for expenses such as:
- rent or house payments and maintenance
- food and house supplies
- car and transport
These days, you could even throw your phone and internet bill into this list.
People often make the mistake of choosing their desired quality of life first and spend accordingly, but that will get you into all kinds of financial trouble. Instead, adjust your lifestyle based on this budget of what you can realistically afford then work to earn more money and improve your living conditions. That means cutting costs, for example, by finding housing in cheaper areas to reduce rent and restricting your central heating to certain times of the day. This is the mindset that builds wealth and can be a humbling experience for some but that hardship also provides motivation and an appreciation for the 30% of wants you get to enjoy.
Spend 30% on wants
Once your needs are sorted, you can focus on wants. These are things that can improve quality of life but aren’t essential e.g. gym memberships, coffee and eating out. Calculate 30% of your income and compare that to what you currently spend on luxuries so you know if you need to cut back or have surplus to put towards a holiday. Following the previous example, £1,997 a month would leave you with £599. If you’re not a massive shopper, you’re better off reallocating some of this money to savings, or even needs if you factor in child care and such. Just remember, the 50/30/20 rule is split to provide a healthy life balance so be careful shuffling it around too much.
The list of wants can be endless but common examples include:
- Eating out and takeaways
- Alcohol and cigarettes
- Clothes shopping
- Events and classes
- Books, courses and webinars
- General use items
Sometimes we trick ourselves into thinking that we need things. Don’t fall into the trap of justifying a smart watch because it will track your health or a coffee machine because it’s cheaper than Starbucks. You’ll probably try to convince yourself that one thing is on the way out and needs to be replaced. That’s fine but still assume it’s a want unless it’s a fridge or something equally critical.
Spend 20% on savings
Even though needs is a priority to live, the final 20% is the most important because savings provide the foundation of wealth. If you’ve picked up a book on personal finance, you’ve probably heard the golden rule to ‘pay yourself first’. In other words, as soon as you get paid for the month, set money aside to invest in your future. This remains as true as ever and 20% is exactly how much you can aim for. On £1,997 a month that equates to £399. If you made an average of 10% interest on that amount each year for the next 30 years you would go from £0 to about £823,696 in net worth. So if you learn to make the 50/30 part of the rule work then anyone, regardless of ambition, can easily become financially well off if not a millionaire.
Here’s where you can put some of your savings into:
- emergency fund
- house deposit
- stocks and shares
- ecommerce inventory
- startup business
- debt repayment
- art or collectibles
The reality for many is that of debt repayment. So if you’re off to a bad start then use this 20% to pay off bad debt because high-interest rates can keep you poor, or worse. While it’s not wise to keep too much savings in the bank, this is your nest egg to save for a down payment on property, which could bring you additional revenue from renting it out as well as increasing value as an asset.
Applying the 50/30/20 rule
Luckily, we’ve already covered most of what you need to do.
- Calculate your income after tax so you know the total amount you have to spend each month. Remember to change this when your financial situation gets better or worse.
- Split your current expenses into needs, wants, and savings. Use your banking app or set up a money management app that categorises everything for you so you can track purchases.
- Adjust your spending habits to accommodate the 50/30/20 rule.
And there you have it. A simple way to reorganise your life to achieve the best of both worlds when it comes to being frugal and having fun.