New to budgeting? No worries. There’s a simple rule of thumb you can use to guide your spending without a lot of effort.
It’s called the 50-30-20 rule. Developed by Harvard Law School Professor and bankruptcy expert Elizabeth Warren, this easy formula not only keeps your spending in line, but it helps you continually improve your financial situation.
“You don’t need complicated spreadsheets with countless spending categories, and you don’t need to be a financial expert to understand how much money you can spend,” says Forbes. “You simply need to follow the 50-20-30 rule.”
Start by calculating your monthly take-home income. This is the amount you get after taxes are deducted from your paycheck. Now list all of your monthly expenses, and sort them into the categories of essentials, flexible spending and financial goals. Use the percentages as guidelines to figure out where you might be spending too much—or too little.
Essentials: 50 percent
Essentials are the things you simply can’t live without because giving them up would severely impact your quality of life. These items should consume no more than half of your monthly budget. This category encompasses:
- Rent or mortgage payment
- Health and car insurance
- Medical care
- Minimum debt payments
Flexible spending: 30 percent
Plan on dedicating 30 percent of you budget to the things you want but don’t necessarily need. These are lifestyle choices that may enhance your life. Losing them would be an inconvenience, but not terrible. For example:
- Unlimited smartphone plan
- Cable bill
- Back-to-school clothes
- Non-mechanical car repairs
Financial goals: 20 percent
If you want to reach your goals, make sure you earmark at least 20 percent of your income to put toward your financial goals, such as:
- Building up an emergency fund
- Saving for retirement
- Saving for a down payment
- Paying off debts
If you’re goal is to be free of any debt, remember that minimum payments will be counted in the essentials category, while any extra payments toward debt would be in the financial goals category.
The 50-30-20 rule is a great way to simplify your budget. The percentages are meant to be used as guidelines to help you get started—you can tweak them a bit to make your budget work for you.
“It’s not about the exact percentage breakdown, because all budgets will be slightly different,” says financial planner Eric Roberge.
“The key is to take action and use a system to help you stay consistent in managing your money every month, and making sure you’re covering your expenses, being responsible by saving for tomorrow, and giving yourself some room to enjoy life today.”