Your budget shouldn’t be a financial fairy tale — an unachievable wish list that’s reminiscent of a New Year’s resolution with no chance of success. It should be a practical and attainable strategy that’s achievable with a bit of planning and dedication.
A well-devised budget can help you to attain financial freedom. It can also be a contributing factor if you’ve been exploring what impacts your credit score — with a view to bettering it.
If you’re new to budgeting, learn how to get the ball rolling on financial independence with the handy 50/30/20 rule.
Table of Contents
What Is the 50/30/20 Rule?
Simply speaking, the 50/30/20 rule is a way to break down your after-tax income into three easy-to-manage categories:
- 50%. Spend on Necessities.
- 30%. Spend on Frivolities.
- 20 %. Contribute to savings or chip away at debt. Credit card debt can negatively affect your credit score. This is how a well-devised budget can help improve it!
What Is the 50?
The 50% piece of the pie is the money you should allocate to necessary payments, things you absolutely cannot go without, like groceries, insurance, your mortgage or rent costs, loans and lines of credit, and utilities bills.
What’s Considered a Frill?
The 30% segment is dedicated to luxury or playful items, like vacations, entertainment, and meals out. Ultimately, these are things that, while making life more fun and exciting, you can get by without.
Dedicating a set amount to frills, like eating out, can also help you identify areas of excessive spending. Doing so under the 50/30/20 rule lets you curb overspending and allocate this new-found cash to your savings account or towards cutting down your debt instead.
The Smallest Category
The smallest category goes to savings and payments. Here, you dedicate 20% of your after-tax income to paying off debt, like a student loan or a credit card, and, if possible, to savings, like a retirement fund or a down payment on a home.
While it might be hard to straddle both saving and paying off debt at the same time, if you’re able to cover debt costs every month, it’s more than worthwhile putting the difference aside into a high-interest savings account that’s dedicated to a long-term goal.
The Limitations of This Budgeting Strategy
The 50/30/20 guideline is ideal for those who are making a moderate income where it’s plausible that the allocated 50% will cover necessities. Lower-income households might struggle to allot half of their income to this category — especially if they live in a major city with a higher-than-average rent.
On the other hand, high-income households may find that spending 30% on luxuries equates to an obscenely high amount.
Make It Work for You
Fortunately, one of the merits of this technique is that you can massage and readjust until it works for you. For example, this may involve flipping the last two categories by dedicating 30% to savings and debt and 20% to fun and leisure.
The Bottom Line
If you’re new to budgeting, the 50/30/20 rule is a great strategy to get the ball rolling on the allocation of your monthly income. You might find that you outgrow it quickly, and you want to explore more profound budgeting strategies that help better your savings and your long-term goals.
Whatever your journey, taking that first step towards categorizing your budget and allocating costs is key to a brighter financial future.