There are many ways for people to manage their finances. But if you are someone who has never followed an official structure with your budget, you could find yourself in financial distress. Before things get too far out of hand, you may want to take a look at the 50/30/20 rule to get a handle on your money.
This strategy for personal financial management breaks your budget into three primary sections: 50% for needs, 30% for wants, and 20% set aside for savings and investing. This method is meant to take an overall approach to your monthly expenses without getting too complicated.
As an example, let’s do some quick math:
* You bring home $4,000 a month after-tax
* $2,000 is budgeted for your needs
* $1,200 is set aside for your wants
* $ 800 will go to saving and investing.
What Are Your Needs?
Needs are comprised of the essential items, such as:
- Vehicle or transportation expenses
- Debt payments
Many people have a hard time distinguishing between a need and a want. Often, we think we “need” many things that, in reality, are not necessary for survival. The critical question is, “If I lost my source of income today, what bills would I need to pay to survive?
If your actual needs exceed 50% of your budget, you should look to increase your income.
Even if you think you are in a solid financial position, it is prudent to evaluate your spending in this way periodically. It allows you to continually return to what is genuinely necessary. You start to realize that even though you can afford something, it doesn’t mean you should spend thousands of dollars per year on something that is not.
Typically, housing and transportation are your most significant expenses. Identifying ways to reduce those expenses will help you come within budget. You may be able to find a more affordable apartment or refinance your mortgage. You can consider switching out your vehicle if you have a large monthly vehicle payment.
Defining Your Wants
Wants are defined as those things that you enjoy.
Wants may include items such as:
- Movies and Concerts
While this method allows 30% of your budget for wants, some experts think that is too high of a percentage for disposable income. While you may use your entire allotment for these items, the goal should always be to limit these expenditures. In other words, 30% is the absolute top end for this category.
One place where savings may be found is through subscription TV services. Most people have multiple services that they pay for monthly, and cutting one or two from the lineup can save budget money monthly. Eating out at restaurants is notoriously dangerous for those looking to stay on a budget. However, you don’t have to give up restaurants if you love to go out – look for coupons, two-for-one deals, or specials. Shopping for travel options can also keep your yearly road trip from breaking the bank.
\This category also includes any short-term savings for a new computer, a new car, or those designer shoes you’ve been eying. Never cut into your long-term savings allotment for these items.
As with your needs category, exceeding the allotted 30% for wants is a sure sign that you are overspending for your income level.
Finally, Your Savings Account
The last category of the 50/30/20 rule is to commit 20% of your after-tax income to savings. While needs and wants take care of you in the present, savings protects you in the future.
Some financial experts consider 20% too low for the best savings strategy, but the reality is that most Americans barely save at all. If you can get in the habit of saving this amount every month, you will generally be in a safe financial position.
Your savings should be broken down into several sub-categories. The first is an emergency fund, and everyone should strive to establish a $2,000 fund that can be scaled according to the situation. These funds are critical to bail you out of an unaccepted situation – such as your car breaking down – without having to use a credit card.
Your next category should be a retirement account. According to research, 40% of Americans are concerned that they don’t have enough saved up for retirement. In fact, the average in America is $65,000 in savings, which will not sustain a retiree for very long. Be sure to look into your available options, such as a 401K from your employer or a personal IRA.
If you are looking to invest, the traditional portfolios include real estate and stocks – but these markets have been volatile as of late. Be sure to speak with a financial advisor to determine the best mix of investments for your unique situation.
The 50/30/ 20 rule works for many because of its flexibility. You can shift the percentages based on your lifestyle, stage in life, or personal spending patterns – but the goal is never to exceed 100% of your income and begin to rely on debt. Of course, life sometimes happens. While the method is meant to protect you through short-term issues, circumstances can catch you off guard.
If you are in a financial crisis, you may need to speak to a bankruptcy attorney to help you get a fresh start. Richard V. Ellis is a personal bankruptcy attorney located in Sarasota, Florida. He has helped hundreds of people to get back on the road to financial freedom.