What Is the 50/20/30 Rule of Personal Finance And Why Should You Care?
This personal-finance guideline is a very simple tool allowing those just starting out learning personal-finance to know where to allocate your money. The best thing about it is it is easy to understand, easy to track, and allows for easy planning to get you on the right track in leading a financially responsible life.
Even though it was originally designed to help out the younger generations starting their financial budgets, whether it was those just out of college or those landing that first full-time job, it’s principles can be applied easily as a starting point for anyone.
So What Do the Numbers Mean?
The 50–20- 30 numbers represent your income as a percentage of your total income. The 50 represents 50% of your income, the 20 equals 20% of your income, and of course the 30 equals 30% of your income. Pretty easy so far right? I would hope so. If not, we’re in trouble. Those percentages of course when added up, equal all of your income.
Okay so back to the numbers.
By breaking down your income into these percentages you will be able to see where you need to spend your money in order to have a prosperous financial plan in place.
The Essentials-50% of Your Income
You should be spending 50% or less of your income on essential items. These are expenses which are the absolute necessities in your life. Yes, not everything you think of as a necessity really is!
There is a lot that falls into this category though. In general, most of these things will be the same for almost everyone. Items in this category include housing, food, transportation costs, and utility bills. While the amounts will vary based on your income and also where you live, the percentage of your income you use to pay for these items should be about the same.
Because this category is the biggest, it is also one of the best places to trim your spending. Maybe you don’t need such an expensive car. Maybe you can save a little on the electric bill or telephone expense. This is where you would trim your spending to remain below the 50% mark of your total income.
Your Financial Goals-20% of Your Income
This is where you would allocate your money towards savings. I know it may sound like a lot of money to save at first but if you follow the percentage rule, you will be able to find 20% of your income to put into some type of savings plan.
The 20% you put into the savings part of your plan doesn’t just go into a savings account. It is used for paying back debt, maintaining an emergency fund, along with saving for your future.
This is the “get ahead” category which allows you to actually move forward in your financial life. When you are young the word “retirement” might seem too far away or meaningless to you. But instead think about this category as a “getting ahead” tool, and you’ll soon realize that you can “get ahead” at any time in your life, not just when you’re old and approaching retirement age.
Just remember also that this is the category where compounding interest plays a huge role in your financial success. The earlier you start saving the bigger the effect time becomes in being your best friend.
Your Personal Spending-30% of Your Income
This last category is one where you can make the biggest overall impact in your budget or plan. And the reason for this is because all of it is comprised of unnecessary expenses that you make for various reasons or for lifestyle choices.
What you spend here all depends on what you want out of life and what you’re willing to sacrifice. There is no right or wrong answer to this, it’s just what it is.
But there is a lot spending that goes on in this category that you need to really look at. If you keep it below 30% of your income then you should be able to achieve your goals in the other categories, especially the savings goals which is where you really make progress overall.
The personal spending section includes items such as your cell phone plan, cable bill, Internet fees, dining out, trips to the coffee shop, entertainment, trips and vacation, among other things. Although certain items in this category may not seem to be unnecessary such as your cell phone plan, there is often a lot of wiggle room as to how much the expenses should be.
You are the only one who can decide what is truly necessary and what is discretionary, but remember this is for you not for anyone else.
To Wrap It Up – Conclusion
This 50 – 20 – 30 plan is just a tool that is easy to use and easy to understand, and therefore hopefully easier to follow. You only have to break down your spending into three categories in order to follow this plan. From there it is easy to track how much you’re spending, percentagewise, in each area.
Just make sure you’re staying under the percentage for each category and you will be off to a great start. If you are not staying under the percentages, then look closely at your spending and see where you can make the necessary adjustments.
Above all remember that the savings portion should be looked at as your ability to “get ahead” in life financially. The more you can contribute to this portion, the more you will actually earn overall because of savings on interest charges and gains from your investments. This will allow you to have more money to spend in other areas without going over in each category, percentagewise.
Tell us your thoughts on this plan and if you have used it before. We would love to have your input and comments on it.