Most financial experts swear by the 50/30/20 Rule. According to them, you can purpose most of your income by following this relatively simple budgeting plan. While the 50/30/20 Rule works well for most people, there are times when you may want to adjust how you spend and save money.
Once you understand how the rule works, and when you should break it, you can put yourself on the path to financial success.
Understanding the 50/30/20 Rule
According to the 50/30/20 Rule, you should divide your post-tax income into three categories:
- Living expenses and essentials
- Flexible spending for unnecessary expenses
- Savings and debt repayment
Once you have divided your income into these categories, you should make an effort to adjust how much money goes into each one. As the rule’s name suggests:
- 50 percent should go to living expenses
- 30 percent should go to flexible spending
- 20 percent should go to savings and debt repayment
Why the 50/30/20 Rule Works for Most People
The 50/30/20 Rule works for most people because it encourages them to use their money wisely without forcing them to spend a lot of time and energy thinking about their budgets. You may want to spend your money in a smart way, but that doesn’t mean that you want to spend hours each week going over your expenses. The 50/30/20 Rule simplifies the process.
The 50/30/20 Rule also works well because it encourages you to set priorities. If you follow its guidelines, then you will invest money in your home, decrease high-interest debt, and save money for the future. Just as importantly, you won’t spend too much money on unnecessary expenses like going out to eat or seeing movies in a theater.
When the 50/30/20 Rule Doesn’t Work
The 50/30/20 Rule makes a lot of sense, so you should follow it if it’s feasible. The Rule, however, doesn’t work for everyone.
If you live in a city with a high cost of living, then you need to budget your money differently than people who live in cheaper towns. A recent study shows that the typical New York City household spends nearly two-thirds of its income on rent. Other cities where you need to spend more than 50 percent on housing and other essentials include:
- San Francisco
- Washington, D.C.
- San Jose
- Los Angeles
If you live in one of these areas, then it’s unlikely that you can keep your essential living expenses below 50 percent of your income.
Adjusting the 50/30/20 Rule to Fit Your Life
Since your city’s cost of living affects how you spend your money, you should think about that when creating a household budget. If you spend 75 percent of your income on housing and other essential expenses, then you need to draw money away from the other two categories used in the 50/30/20 rule. Ideally, you will lower how much money you spend on non-essential expenses. That way, you can keep saving money and repaying debts so you have a secure financial future.
If you plan to buy a home, however, then you can feel confident taking some money from the savings category. You’ll essentially turn the money from savings into an investment by putting it toward the cost of your home, which you can sell at a higher price a couple of decades from now.
Budgeting is important, but it needs to fit into a realistic plan that considers your city’s cost of living. It’s a good idea to follow the 50/30/20 Rule as closely as possible, but the price of real estate may force you to make adjustments.