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If you want to improve your finances and meet your financial goals, you need to learn effective income allocation and budgeting strategies that can help you make sound financial decisions. Creating a budget or allocating your after-tax income can be quite challenging, mainly because most budgeting plans tend to be complicated, rigid, or ineffective.
Fortunately, the 50/20/30 rule was created by a US senator – Senator Elizabeth Warren, as a simple budgeting technique to help people manage their money.
The 50/20/30 rule of thumb encourages people to split their earnings into three categories; 50% to ‘needs,’ 20% to ‘savings and debt repayment,’ and 30% to ‘wants.’
Experts have described this rule as the ultimate lifetime money plan because it’s easy to use and implement. It essentially simplifies personal finance, income budgeting, and the allocation of after-tax income.
In this article, we will discuss the 50/20/30 rule of thumb in detail, so keep reading to determine whether it’s right for you.
What is the 50/20/30 Budget Rule
As earlier stated, the 50/20/30 rule is aimed at helping you allocate your monthly income and meet your financial goals.
To apply this rule effectively, you need to understand the three categories of income allocation; needs, wants, and savings.
50% Needs
Once you’ve received your take-home pay or income, 50% of it should be devoted to meeting your needs. Needs are mandatory expenses or things you cannot live without. They are critical aspects of your financial life and personal finance because they are living expenses you need to pay to survive. They include rent, groceries, utility bills(water, electricity), and mortgages.
50% of your after-tax income should be enough to meet your needs. Otherwise, it would be best if you considered reducing the expenses in your ‘wants’ category. This helps you ensure that all you require to survive are readily available – healthcare, electricity, food, and groceries.
For instance, if you make $10,000 monthly, $5,000 should be allocated to your needs. While making your monthly budget, the ‘need’ category takes the highest percentage because it’s the most important.
30% Wants
Thirty percent of your take-home pay should be allocated to your wants. Wants are desires you have but don’t need to survive. They are nonessential items and expenses that you can live without.
Examples include high-speed internet, dining out, vacations, and shopping for the latest clothes and gadgets. If 30% of your take-home pay isn’t sufficient to meet your wants, you can consider reducing your expenses.
You can take public transportation instead of purchasing a luxury car or work out at home instead of buying a gym ticket. The goal is to manage your wants and desires to control your living expenses.
20% Savings
Finally, 20% of your monthly income or earnings should be allocated to savings and debt payments. You can create a saving plan and save money for several purposes, including emergencies and retirement. You can also hire a retirement income certified professional to help you generate retirement savings and retirement contributions.
Additionally, you need to create an emergency fund from your savings account. This helps you cater to emergencies and unplanned expenses such as accidents.
Besides saving for retirement and emergencies, you need to pay off your debts by creating a debt repayment plan. Debts could include mortgages, bank loans, or credit card debt.
Allocating a percentage of your income to debt repayment and savings ensures that you prepare yourself for emergencies while paying off any debts that can hinder your financial goals.
What is the Importance of Savings
Saving is a practice that is widely encouraged in the financial planning industry. It involves putting away a percentage of your income for future uses. There are two main reasons why you should save;
- Saving Provides Financial Security: Having some money saved is a great way to prepare yourself for unplanned expenses and emergencies. It allows you to live life freely, knowing that in case of any eventuality, you will have some money to cater to your needs. Whether you lose your job or incur sudden healthcare expenses, saving provides the financial backing to get through difficult life situations.
- Saving Aids Financial Planning: Saving money is a great way to plan toward achieving your financial goals. It helps you make better financial decisions and actively work on your goals. If you need to set up a business or make an investment, saving is a great way to raise capital. Individuals without savings may have to take loans and incur debt before making significant financial investments.
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Conclusion: 50/20/30 Budget Rule
Most income allocation templates are difficult to understand, but the 50/20/30 rule is a simple budgeting method that helps you allocate your income effectively. The budget categories are; 50% needs, 20% savings, and 30% wants. These are concise enough to make budgeting easy yet comprehensive.
If you’re new to budgeting, you need to track your spending and income allocation to ensure that you are meeting these percentages.
Budgeting is extremely important, and if you need to create a simple and effective budget, the 50/20/30 rule is a great way to begin.
50/20/30 Budget Rule FAQs
Should the 50/20/30 rule apply to every budget?
This decision entirely depends on you. Some individuals find it easy to implement this rule in all instances, while others don’t. For example, low-income earners are likely to spend more than 50% of their income on their needs, leaving this more than 20% for savings and debt payments. Such individuals find it difficult to apply this rule to every budget.
Individuals who have to pay mortgages or repay their student debts may spend a lot more than 20% of their income on debt repayments.
However, the 50/20/30 rule has produced excellent results for a lot of individuals and families by providing a simple method of planning their financial lives.
Ultimately, you can adjust your budget as your income and needs evolve because the best budget is one that’s tailored to your needs and financial goals.
What is 70/20/10 rule money?
The 70/20/10 rule is a budgeting rule that requires you to divide your income into three categories;
- 70% for your expenses
- 10% goes to debt repayment or donation
- 20% goes to your savings and investment
