Between saving for a down payment on a home and making sure you have enough money to pay your mortgage each month, budgeting is vital. Trying to figure out how to pay for food, utility bills, fun, insurance, loan repayments, and much more all within one month’s paycheck can be incredibly taxing, and leave you feeling overwhelmed and stressed out. Let's simplify it into some easy steps.
The 50/30/20 rule
Divide your monthly after-tax income into 3 categories
50% calculate of your monthly after-tax income on needs
30% calculate of your monthly after-tax on wants
20% calculate of your monthly after-tax on savings/paying off debts
Knowing exactly how much money is exactly in each category makes it easier to keep to your budget.
Spending 50% on needs may look like:
Monthly rent/ mortgage
Electricity, water, and gas bills
Minimum loan repayments
For example, if your monthly income after tax is $4,000, $2,000 should be set aside for your needs. While this budget will differ from person to person, if you cannot fit your needs into 50% of your budget, you may need to make some changes to lower expenses. This can range from simple changes like changing internet or energy providers, using coupons, or buying off-brands when buying groceries, to more significant changes such as finding roommates or less expensive housing.
On the flip side, even if you are working well within your 50% cap and falling below it every month, it can always be a good idea to revisit fixed expenses occasionally. You may come across an opportunity to save even more, allowing you to put even more money towards your wants or savings.
Spending 30% on wants may look like:
Shopping for non-essentials
Entertainment subscriptions (Netflix, MAX, Hulu, Amazon Prime, etc)
Continuing with the example of a monthly income after tax being $4,000, then $1,200 would be 30% of the $4,000. This means this person would have $1,200 a month to spend on non-essential items in this case. This doesn’t mean you aren’t allowed to go out and have fun; it simply means you have to be more mindful about how much you spend when out and about. Remember, the less you spend one month in this category, the more you can roll over to spend the next or tuck away toward savings.
Keeping 20% for savings
Having spent 50% of your monthly income towards your needs and 30% towards your wants leaves 20% to be stored for savings to put towards outstanding debts. Although minimum payments are considered needs, paying more will reduce your debt and future interest, classifying it as savings.
Regarding the savings section of the budget, you may be trying to pay off debt and save for the future simultaneously. A simple way to do this is to alternate between putting the 20% in your savings account one month and adding the 20% to your minimum debt payment the next. This way, you are both creating a savings account while getting ahead on debt payments.
In our current example, the remaining $800 would be stored away in the bank or put toward debt payments. Per this pattern, a person with the same income would be able to save $9,600 in just one year!
You are building a better, more stable savings plan by consistently putting away 20% of your pay each month. This technique works whether you intend to build an emergency fund, put a down payment on a house, or are just trying to develop a long-term financial plan.