May 2, 2023•
5 min read
The 50/30/20 rule can be a money magic wand for budgeting and paying off loans quickly. This is a simple method that helps you manage your money effectively. All you have to do is to divide your monthly after-tax income into three categories of expenses. Allocate 50% to non-discretionary expenses, 30% to non-essential needs, and 20% to savings or debt payments.
If you regularly allocate your budget to different categories, your money will work for you more efficiently. Since there are only three groups, you will have a real opportunity to save not only money but also time, as well as significantly reduce stress and not think about minor details. Adhering to the 50/30/20 rule can help you achieve your financial goals quickly. The essence of the idea is to track your income and spending, and then learn how to manage them so that you do not go into debt, are prepared for life's surprises, and create a financial cushion.
The author of this sensational technique is Alexa von Tobel. You can still find her book Financially Fearless, which became The New York Times best-seller, on bookstore shelves around the world. Tobel was prompted to develop her own rule for budgeting by disappointing statistics: 76% of Americans live from paycheck to paycheck. Furthermore, in her opinion, most young people enter adulthood with impressive student loan debts. As a result, they are not able to save money for the future. Along with loan payments that need to be made monthly, most of their earnings are spent on rent and other essential expenses. However, a well-known psychologist and financier believe that it is still possible to stop this snowball effect. All it takes is budgeting and allocating your expenses properly: thus you can save money and not deprive yourself of pleasures.
To effectively manage your income, set aside 50% of your monthly earnings for all non-discretionary expenses. These are things you can't abandon: apartment rent, an auto loan or mortgage, public transportation, groceries, and utilities. 30% should be spent on leisure activities such as shopping, cinema, restaurants, and beauty treatments. These things are important, and you can choose whatever you like. However, remember to employ a rational approach to your expenses and live within your means. The remaining 20% should be used to pay off small loans and other debts, if any. If you are free of debt, set this money aside.
Of course, at first, you may have difficulties implementing the plan. There are times when half or most of your income is spent on rent alone. However, the 50/30/20 ratio is at least something to strive for. You may have to reconsider your rental conditions and opt for a more affordable option and refuse to buy a car. At the same time, von Tobel asks you to keep some money for yourself so as not to lose motivation to pursue your goals. Even if at first you save very little money, do not worry about that: the main thing is to start.
Non-discretionary monthly expenses may include utilities such as electricity, water, and heating, as well as other essentials, for instance, rent for the apartment and home appliances, clothing, food, transportation, and medicines. Sometimes life, health, or property insurance is added to the list.
By reviewing expenses in this category, you will easily see if you really live within your means. If all essential needs take up half of your budget, this is normal. If the situation is the opposite, this is a good reason to think of and reconsider the allocation of your personal finances. For example, if you spend 40-45% of your earnings on rent, the budget will be unbalanced. Also, if your commute to work is too long and requires a lot of changes, which entails an increase in expenses, it makes sense to look for housing with a better location.
The first step is to determine the bottom limit of your spending and build on that.
Constant self-restraint is hard to cope with and puts too much pressure on you. It is almost impossible to achieve your financial goals without momentary joy. Making life enjoyable and fun is good for your health, so you can spend 30% of your income on pleasant things without hesitation. Of course, you can live without a streaming service subscription, restaurants, or a new pair of shoes, but you do not have to deny yourself all pleasures.
Unlike non-discretionary spending, expenses on your wants and wishes can be managed. For example, if you want to start exercising, you can buy a membership in a professional fitness center, you can choose a gym with a minimum set of equipment at a reduced price, or do it at home. Or instead of eating out, you can cook cassoulet in your own kitchen.
However, this works the other way around too. Let's say you have allocated €1000 for your non-essential needs, and now it is two days until payday, and there are €500 left to spend. The remaining amount of money can be set aside, or you can enjoy a delicious steak at a nearby restaurant.
It is best to set aside 20% of your budget for the future or for paying loans. First and foremost, you should save for a financial cushion. This amount of money should be enough for you to easily live without a steady income for three to nine months in case of a sudden layoff. Also, the money you set aside can be used to pay for a sudden expensive medical treatment or an urgent purchase of large household appliances such as a refrigerator, stove, and so on.
You can also invest your savings to increase your income. The methods can be different: you can open a deposit account in a bank, or invest in stocks. There is no one-size-fits-all option, the main thing is to think over your investment strategy in advance.
You should not worry about saving money too much, count every penny, and always stick to your budget plan. Budget control is important as it helps you keep track of your personal finances and avoid unnecessary headaches. It is best to approach this issue wisely by thoroughly examining the situation and analyzing your needs. In the first stages, it is enough to follow the steps below.
Before you start planning your expenses, you should find out the exact amount of money received monthly in your account. You may have multiple sources of income: salary, bonuses, part-time jobs, or stock dividends.
For example, if your salary is €2,000, you get €500 of dividends every three months, and you earned €4,000 through part-time jobs last year, you can calculate your average monthly income using the formula:
(2,000 × 12) + (500 × 4) + 4,000 = €30,000 per year = €2,500 per month.
Once you have calculated your monthly income, you can move on to the 50/30/20 rule and make a list of expenses.
For example, an apartment with a monthly rent of €600 is too expensive if you live there alone, just like a €200 dinner at a restaurant. With this level of spending, it will be difficult to set any money aside. However, if you are used to spending generously on a comfortable life, strict rules are not a call for instant action, but just a reason to think about optimization. Perhaps you will come to the conclusion that it is time to change jobs or cut expenses. In the latter case, the easiest thing to do would be to reduce spending on entertainment, which does not affect your future.
If you are thinking about saving money, do not rush headlong into the calculations. The best thing to do is to monitor your income and expenses over a few months. During the analysis, you may conclude that there is no need to change anything because you already adhere to the 50/30/20 rule on an intuitive level.
However, as practice shows, you will still have to slightly adjust your budget. For example, it may turn out that your non-essential spending takes up 60% of your entire budget. In this case, you will have to spend less on your wants and allocate money to more important things. Also, if only 30% is spent on essential needs, rather than 50% as planned, you can afford more leisure or start investing actively.
Unfortunately, budgeting always comes with some uncertainty. There are several reasons for that:
Splitting up the budget will not be effective if income is almost equal to expenses. If 80% of your salary goes to non-discretionary expenses, you cannot spend on leisure and save money at the same time. You will have to choose one thing.
It is easy to cheat yourself.
Food is an essential spending category. However, food comes in many forms. Let's say you can't do without a full breakfast, lunch, and dinner, but this diet does not include chips and snacks. Fast food should go on your wishlist and not be included in your non-discretionary expenses.
The percentage of your savings directly depends on your goal.
If you plan to build a house in 5 years, you need to save more money, for example, 40% instead of 20%.
If you save €600 a month, you will have €36,000 in five years. That is not enough money for a house. However, if you increase your savings to 40% per month, that would be €48,000 in five years. This amount will be enough for a small and cozy cottage.
The best way to budget using the 50/30/20 rule is on a spreadsheet. Microsoft Excel, Google Sheets, and Apple Numbers are good for this. You can also find many budgeting mobile apps.
The main thing is not to put yourself in rigid frameworks and to allocate your budget comfortably.
The 50:30:20 effective budgeting rule can be a great tool for managing your finances and achieving your financial goals. However, implementing it can be challenging without the right resources and support. This is where CFPS financial management app comes in. Our app offers a convenient and user-friendly interface and we are working hard on introducing the functions of easy tracking of spendings, setting budgets, and analyzing your financial performance. With our low commissions and free tools, you can take control of your finances and achieve your financial goals faster.
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