In this post, I’m going to teach you how to budget your money effectively with the 50/20/30 rule.
If you’re not currently operating your finances to a budget I strongly recommend you try. Setting up a budget will give you visibility over your finances. It helps you understand where your money is going so that you can reposition where you want it to be going. I was able to pay off $5000 of debt in as little as 6 weeks by setting up a budget and keeping to it.
If you need help on understanding more about budgets check out the following posts:
- What is a Budget Plan?
- How to Make a Budget Planner
- The Most Effective Way to Cut Your Budget
- Why a Cost-Cutting Strategy Helps You Pay Off Debt Quickly
You can even download a copy of my free budget planner on Google Spreadsheets.
My free budget plan helps you organise your expenses into categories. My post ‘The Most Effective Way to Cut Your Budget‘, explains fixed and variable costs in a budget. These concepts will help you when applying the 50/20/30 budgeting rule.
There are may approaches you can take to budgeting. One of the most popular methods is the 50/20/30 rule. This rule is best applied once you have some visibility over what you are spending your money on
What is the 50/20/30 rule?
The 50/20/30 budgeting rule can be broken down as follows:
50% – Fixed or Essential Expenses
50% of your total income is apportioned to fixed or essential expenses. These expenses are your main priorities, the expenses you cannot live without. They include rent or mortgage, loans, subscriptions, travel costs, insurance and phone amongst others.
These are generally considered to be your needs as opposed to your wants. I find that a little misleading, however.
Food is a need but does not come under this category. Food is a flexible expense and would fall in the 30% segment of the rule. This is why I prefer to call this segment your fixed expenses.
20% – Financial Goals or Savings
20% of your total income is put toward your financial goals such as savings.
This will include the likes of an emergency fund and savings account to cover 6 months of expenses as priorities. Then you would save for a college fund or retirement fund through investments.
If you are in debt then you may consider that paying off debt is a form of saving. In my view, you would be right. It is very likely you would be reducing the amount of money you’d be paying in interest on any debt. Putting these funds toward paying off debt would be sensible.
I would, however, recommend building up an emergency fund of at least $1,000 first.
30% – Flexible Spending or Variable Expenses
The final 30% of your income is used for flexible spending or variable expenses. These are your lifestyle expenses.
These types of expenses vary. They include phone usage charges, groceries, gas for your car, eating out, entertainment and hobbies.
You generally have more control over the level of spending in these areas. They are the first set of expense to cut back on when trying to make savings or find extra money.
The 50/20/30 Rule is a Guideline
It’s important to remember that the 50/20/30 rule is a guideline. It is intended to help you approach the management and apportionment of your finances effectively. Doing so will help position your finances for the future.
The rule becomes powerful if you apportion your income rigidly to each tier from the top down. That is to say, 50% is applied to fixed costs as a priority, then 20% to savings or financial goals. The remaining amount, which may equate to 30% is what you live off.
If your fixed costs are minimal you may find you don’t need to assign 50% of your income to the first segment. You can utilise this surplus toward savings or living costs. Your finances are on a good path if this is the case.
Likewise, if you cover your costs in all three segments with ease you will have surplus funds at the end of the month. You can opt to top up your savings at the end of the month or roll it over to next month.
The 30% variable expense should be guilt free spending money. This is because you have prioritised saving for the future in your 20% tier.
Alternatively, particularly if you are living beyond your means, you may not have 30% left to cover variable costs.
Whilst this is a problem, the power in this rule becomes evident at this point.
If you are strong minded enough, prioritise the first two tiers. This ensures you are saving 20% of your income every month despite the shortfall of money coming in. Your financial goals become the priority.
It will ensure you save for an essential emergency fund. It will help you build savings for 6 months of living expenses for the day the shit hits the fan. You’ll then be working toward your long-term financial goals. These goals could include investments or retirement funds, or some other financial goal.
You will then need to find the extra money for your living expenses.
In experiencing, or even suffering, a month or two of living on what is left, you’ll grasp the need to cut back on expenses, if you don’t beforehand.
If you’re in a position where you need to find extra money fast, cost-cutting in a budget is the fastest way to do that.
How you approach cutting back on expenses in your budget comes down to your priorities. If you are social-butterfly and love eating out then cut back on fixed expenses. Find a cheaper place to rent, for example. You may want to carpool to save on travel costs.
If you can’t cut costs, the alternative is to raise your income, which can be harder to achieve.
In some cases, your retirement savings may be deducted from your salary at the source. It’s much better to adopt a position of “out of sight, out of mind” in respect of the 50/20/30 rule. What I mean by this is you should apply the rule to your take home pay only. In addition to a percentage of your salary put towards a retirement plan, 20% of the take home pay applies to future savings. This will force you into good habits and set you up well for the future.
Do you and your family keep to a budget? If so, what do you think of the 50/20/30 rule, would you ever use it? Have you already used it and how did you find it?
Don’t forget, you can get a free copy of my budget planner by signing up to my mailing list. I can guarantee that setting up a budget will be one of the most sensible things you can do to keep money in your pocket!