Tuesday, 5 November 2019

How To Manage Your Money - 50 20 30 Budget Rule

50 20 30 Budget Rule

In today's article I'm going to share something called the 50 30 20 rule of money, this is a very important concept to understand, especially, if you've ever found yourself in a where you want to same more money or you want to invest more money, but you're not really sure where that's going to come out of your budget, how you're going to be able to start doing it, putting in 20%, 30%, 40% of your income and finding a way to start saving and investing. So that, potentially, you can retire earlier, you can afford to pay for your kid's college and so on.

There's a lot of reason why we'd want to save and invest money.

But let's talk about this rule of money, very important to understand and I think a lot of people are going to find some value in this. 


50/30/20/ Rule Of Money

  1. Calculate Post-tax Income
  2. Add Back Non-tax Deductions
  3. Create Your Budget

It's been around for quite some time and for the most part, it's a really helpful idea and tool that you can use in order to build wealth. I'm going to talk about some downsides to it and some things that you want to be very careful of if you're going to follow this strategy. But overall, it's definitely something that in most cases is going to put you in a much better financial position than you would be.


Calculate Post-tax Income

To do this, simply look at your pay stub, look at how much money is coming into your bank account after taxes. You're probably going to be getting taxed, your employer is going to be withholding a certain amount of money for taxes, and then you get a certain amount of money in your bank account.

If you're making $45,000 per year, you might only see $35,000 per year, coming into your bank account.


Add Back Non-tax Deductions

What you're going to do then is add back any non-tax deduction, health care, or if you've been making deductions for 401ks or IRAs or some other types of retirement accounts. Then add that back into this equation just to give us this example number that we're going to talk about. How we can use this 50/30/20/ Rule.


Create Your Budget

You want to make sure that you are running a budget at all times.


Once you do these 3 things, that's when we can start talking about the 50/30/20/ rule of money.

Needs - 50%

  • Housing
  • Food
  • Health care
  • Utilities
  • Minimum Debt Payments

This 50 stands for 50% of your money goes towards your needs. This list is just a guideline, it isn't to say that this is exactly what you should be at, at the moment. But more something that you should be shooting for and hoping to get your needs down to about 50% of your income.

The truth is, if you're making $7.25 an hour, it might be very difficult to get your needs down to 50% of your after-tax income. If you're making $15, $20, $30 an hour, it might be a little bit more possible to do this depending on where you're living at the moment.

Housing

The idea here is that 50% of your income is going towards needs. I want to very much clear what we mean when we say need. We're talking about putting a roof over your head, we're not talking about the best school district in the county, we're not talking about a really nice condo somewhere. We're talking about something that gets a roof over your head that counts as a need.

Food

Some people spend a lot of money on foods, we're not talking about restaurants, this is under the needs category, this is food such as groceries that are very important to survive. We obviously all need food, we need shelter to survive.

Health care

This is something regardless of your income you should not be skimping on, because the truth is, if we don't have good health, we're probably not going to be around for a very long time, so take good care of yourself.

Utilities

Not getting your power shut-off, not getting your water shut-off, not getting evicted from your home, so these are all very important things that are needs.

Minimum Debt Payments

When we say this, the problem with this is that you could have maybe bought a TV with your credit card but you have minimum payment on this, well, the TV is not a need, but a need is to pay off that minimum payment on the credit card at the very least. so we throw that into the needs category for this.

Going along with this minimum debt payments, if you have student loans, car loan, all these things that are going to affect your credit score if you don't pay them, you essentially default on the loan, that's very bad news. If you don't want to find yourself in that position, we're throwing that under needs as well for minimum payments.


Wants - 30%

  • Clothing
  • Phone
  • Restaurants
  • Entertainment
  • Vacations

According to the 50/30/20/ Rule. 30% of your income should be going towards your wants. There is a very large difference between needs and wants and hopefully, we're clarifying that in this article.

Clothing

I would classify this for the most part as a want, obviously, you shouldn't be running around downtown completely nude, just running through the street, you're probably going to get arrested.

The truth is, clothing doesn't have to cost a lot of money. If you weren't in a financial pinch, you can go to 50 cent's Sunday at Goodwill or Salvation Army and get some clothing for $0.50. For a couple dollars, you get some clothes. For the most part clothing, I would classify it as a want, there is a very small need for clothing, you could budget some of that infinity to maybe $20 a month.

Phone

This is something that is not necessary to keep you alive, it's not necessary to keep you off the streets, so therefor, phones and phone bills, these are classified as a want, even though this might be something that's pretty important in life. Really, everybody has a phone and in some cases, you can't even really function without your phone.

Restaurants

if you're going to have to eat, this is a want, this is an obvious want, it's not groceries, it's not paying for bread, rice, beans, potatoes, and vegetables and fruits, but it's things that you're paying the chef to make you food. This is money that is classified as a want.

Entertainment and Vacations

It's not to say that you should not be spending money on these, 30% of your income can go to these under this specific rule, the 50/30/20/ Rule. Because you don't want to end up like a boring person. Who is saving all of his money and not doing any of these and that kind of sucks? Put about 30% of your wants.

Do an audit on yourself, track your budget and see how much is going towards your wants right now, versus how much is going towards your needs. 


Save/Invest - 20%

  • IRA
  • 401k
  • Debt Repayment
  • Emergency Fund

The truth is, I really like to flip these around, I find myself saving way more than 20% of my income and investing more than 20% of my income. If you find yourself making like $30,000 per year, then you would split this down into a very simple thing

$30,000 per year after-tax, 
  • $15,000 goes towards your needs over the course of the year. 
  • $4,500 goes towards your want
  • $10,500 goes to saving and investments including IRA, 401k, etc.

IRA and 401k

If you can get to at least 20%, I would argue that you would likely be in a much better financial position than most people today. the truth is, most Millennials are not anywhere near that percentage, and even if you're just sucking money into your 401k or maxing that out, you're probably going to be in a much better financial position.

Obviously, we can't predict exactly what's going to happen in the stock market or in the market in general, but for the most part, they do go up. 

Debt Repayment

We can put this into the saving and investments because when you look at whether you should pay off debt or invest, I'd like to think of both as something that is beneficial for your financial overall.

Emergency Fund

It's important to have at least close to 6 months worth of emergency fund that you can live off of, if you get laid off from your job, if something happens, if you have to pay some very expensive medical bills, these are all incredibly important.



Conclusion

That is the 50/30/20/ rule, personally what I would try to do is, if you're making over $50,000 per year after-tax, and you're not living in an expensive city, I would switch these number around and go the 50/20/30, rather than the 50/30/20 rule.
  • 20% for your want
  • 30% for your saving and investment 
  • 50% for your needs

30% for your saving and investment 

This little tweak can quite literally shave off years, off of your projected retirement date, instead of retiring at age 63 like the average American, you might be able to retire at age 55. Maybe even age 50 or earlier in some cases depending on how much you can get this up.

20% For Your Want

But just remember, you do want to spend some money on your wants, go on vacation sometimes, make sure that you're budgeting for that, make sure that you are buying things that you do enjoy. If you love playing music, go buy a guitar. Don't deprive yourself of some of these things, but make sure you have this very well laid out.

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