Most people who have been in the working world for several years will probably gladly give this piece of advice to those just starting out: don’t take on any debt unless it is for something absolutely necessary. Otherwise, it’s easy to get to a place where you spend more than you make and begin living on credit to make ends meet. Living on credit is essentially like putting yourself in financial jail. Luckily, there’s another budgeting option available to consider before taking on any debt: the 50/20/30 rule. How does it work and what do you need to do?
What is the 50/20/30 rule?
This rule helps establish a working budget. Here’s how it works. Divide your paycheck (after taxes) into three sections including the following areas below.
- 50% for the necessities of life
- 20% for savings (including retirement accounts) and debts
- 30% for wants, possibly going into a short-term savings account for high-cost wants
What is a need?
The things that fall into this category include keeping a roof over your head, utilities, insurance (home, car, health, dental, and life, as a handful of examples), minimum payments on any credit cards or existing debt, groceries, and transportation costs. Think of a need as something that your quality of life or credit rating would suffer without it.
Savings and debt portion
This 20% of your net income can easily be divided into 10% for savings and retirement with 10% set aside to pay off existing debt. You could easily do it as 5% and 15%, depending on how much debt needs to be paid off. The goal is to put that debt in the past. Once you do that, it will free up more money in your needs category and allow you to put 20% in savings and investments for the future. Until you get that debt paid, the types of things that fit this category include retirement accounts, emergency funds, debt payoff, student loans, and investments.
What are your wants?
You’ll have the best idea of what your wants are for yourself and your family. This 30% portion allows you to have a better quality of life. Ideas and items that are considered as wants include vacations and anything that would be considered an upgrade from what you need, like a new car, designer clothing, entertainment, and dining out at nice restaurants.
Simplicity helps!
This type of budget works for many because it is a simple approach. Your budget doesn’t need to follow these exact percentages, so feel free to adjust them as you need or want. However, since the plan is fairly straightforward it should be easier to follow and following a plan will allow you to succeed financially in the long run.
Mark Angelo co-founded Yorkville Advisors in February 2001. Since its inception, Mark has guided the firm in investing in over 500 financial transactions with a notional value of more than $3 billion.