The fifty-thirty-twenty rule for budgeting.
Budgeting expenses is an action usually taken to manage your finances with a general goal to achieve financial freedom and wealth for the future. However, some of us struggle to find the correct amount to budget. An overall general guideline to follow that could be beneficial is the fifty-thirty-twenty rule of finance. Here is the breakdown of this golden rule that could possibly guide you to financial freedom and wealth.
The general guideline starts with separating your income into 3 parts:
Necessities (50 percent): 50% of your income will cover your living expenses which include your rent, food, and other necessities that you need in order to live as a functioning human being. Other factors might include your monthly car payments, and medical visits, along with dependents such as children, a spouse, or pets.
Wants (30 percent): 30% of your income will go towards your wants. The new pair of shoes, the vacation trip you’ve been saving up for, or even a unique local restaurant that you wanted to dine in at. This is usually considered the play money.
Investments and Debt (20 percent): 20% of your income should be dedicated to investments or paying off debt. Investments might include a 401k, Roth IRA, or an emergency fund during times of financial struggles.
In theory, this should make sense, but I’m a person that likes to see how these numbers play out in a realistic scenario. So we’ll pick a general salary to start off with and work from there.
If you’re an hourly employee I recommend determining your post-tax hourly rate and totaling the number of hours you work in a month to follow the fifty-thirty-twenty rule. And if you are salary, I recommend determining your post-tax monthly income.
According to Forbes, a 2010 study showed that the happiness of people earning a base salary of $75,000 or more begins to plateau, and money would no longer play a significant impact in the financial happiness of the person, however further studies today show that more money can still play a role in a persons happiness even though it may not be as significant.
Business Insider reported that Dan Price, the current CEO of Gravity payments announced that all employees within the company will earn a base rate of $70,000 annually to start off (including himself).
We’ll be using this to implement the fifty-thirty-twenty rule. In order to determine post-tax income in your current state, I like to use a tax calculator tool on talent.com. Here is the general breakdown if Dan was living in Colorado and making a gross salary of $70,000 per year:
This breaks down to a gross monthly income of $5,837 (pre-tax) and a net of $4,437 (post-tax). for the sake of this example, we’ll go off the post-tax net pay.
Monthly base: $4,437
Necessities (50 percent): $2,218.5
Wants (30 percent): $1,331.1
Investments and Debt (20 percent): $ 887.4
Therefore, Dan's monthly Necessities such as rent, food, and payments shouldn’t exceed $2,218.5. His wants (dining out, buying new material items, or vacation savings) should stay within the budget of $1,331.1, and he should use $887.4 of his income to either pay off debt or invest.
Although this is a general guideline to follow. If you are struggling to pay off debt, you could adjust this rule to maybe use 30% of your income to pay off debt and 20% to spend on wants.
Financial planning is based on the circumstances of your situation, and it is important to determine where your financials sit within the means of your standard way of living.