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Emergency Funds – The Buck Starts Here
The 50/30/20 rule budget can be a great tool for people who don’t have the patience for tracking their spending in detailed categories.
The 50/30/20 rule budget only requires you to track and divide your expenses into three main categories: needs, wants, and savings or debt. This reduces the amount of time you have to spend detailing your finances and allows you to focus more on the big picture instead.
To figure out the dollar amount for each category, you’ll need to first calculate your after-tax income. To do this, simply start with your take-home pay on your paycheck and add back any deductions that aren’t taxes. These items may include things like health insurance and retirement contributions.
How to use the 50/30/20 rule budget
The first thing you must do is calculate how much money you can allocate to your needs, wants, and savings or debt. Let’s say you’ve calculated your after-tax income as $6,000 per month. In this case, you’d have $3,000 for needs, $1,800 for wants, and $1,200 for savings and debt.
Now that you know how much you can spend in each category using the 50/30/20 rule budget, the question is which expenses go in each category. You’ll have to use a bit of discretion in determining what fits into each category, but here are some general guidelines to follow.
Needs are expenses that you absolutely must keep in your budget no matter what. These include things like housing, utilities, transportation and health care expenses; at least the minimum payments on your debts; and the bare minimum of basic clothing and supplies for living.
Wants are expenses that you choose to spend your money on but that you don’t need to live your life. This category includes expenses like dining out, alcohol, cable TV, internet, shopping trips, vacations, memberships, subscriptions, gifts, entertainment and other luxuries.
It’s easy to confuse many wants as needs. A simple way to determine if something is a need or a want is to ask if you could live without it. If you could, it’s a want, not a need.
Finally, the savings or debt category is money you set aside for your future or to pay off debt faster than required. You can use this money to build an emergency fund, save for a down payment on a home, invest for retirement or pay off your student loan debt or credit card more quickly than required.
If you want to save money more quickly, you’ll need to set aside some of your wants money for extra savings.
What types of debt should be considered in the 20% of savings and debt?
Only debt payments above the minimum payment required should be considered in the 20% category. For instance, extra payments on credit card debt or a mortgage to pay it off faster would be part of the 20% category. But the amount of the minimum payment would instead count toward the 50% needs category. The reasoning behind this is that not making at least minimum payments on your debt would negatively affect your credit, and for debt like credit cards, cost you additional money in the form of interest.
Is the 50/30/20 rule budget good for you?
Overall, the 50/30/20 rule can be a sound budgeting method for some people. But whether the system is right for you depends on your specific circumstances.
Having just three categories to track might help you focus on fine-tuning your finances instead of getting bogged down in the process of categorizing each individual expense. For others, the lack of structure could make it harder to find ways to improve their spending habits. Ultimately, you need to decide whether a budgeting system that’s less detailed or more highly detailed will be best for you.
Another potential issue with the 50/30/20 rule budget is the breakdown of money allocated to needs, wants, and savings or debt. Depending on your income and where you live, 50% may not be a large enough percentage to cover your needs.
For instance, people who live in areas with a high cost of living may have to put a large part of their income toward housing, making it almost impossible for them to keep their needs under 50% of after-tax pay.
Finally, some critics of the plan say the 50/30/20 rule budget doesn’t work well for higher-income earners, because it calls for too much spending on wants versus needs or savings and debt.
For people who don’t like detailed budgeting, the 50/30/20 rule budget is a simple approach to keeping their finances in check. With only three major categories to track, you don’t have to dig into the nitty-gritty as much as you would with a normal budget.
Unfortunately, the 50/30/20 rule won’t work for everyone because of individual circumstances, such as residing in an area where the cost of living is high. Keep in mind, though, that you can adjust the rule for your particular needs by changing the percentages to match your personal situation and financial goals. If that doesn’t work, there are plenty of other budgets you can try, too.
Hear from the experts
Q: Is there a budgeting rule of thumb you think makes sense for people?
A: “Several books on personal finance recommend starting by constructing a small amount of personal funds for emergencies — say $1000. This isn’t savings as much as ‘getting out of a jam’ money. If one doesn’t have this level of money, all discretionary expenses should be put toward constructing this type of fund.
This amount of money need not be put in a bank — often banks do not allow deposits at this level without fees — just a safe place. A picture frame or piggy bank would be fine. It is important to do this because consumers often suffer most when they have a costly unplanned event and need funds. The avenues for getting these funds quickly are often very expensive. Having a small amount of money ready to cover these occurrences will pay off greatly.
Once this amount is set up, the broader challenge is knowing what is the ideal amount for this rainy-day fund. Sources differ on this interpretation, but I’ve heard rules like “six months of income” to $30,000. One may not reach this level easily, but it should be seen as a guideline for what is the next level of financial security. Once one has this level of precautionary savings, they can feel relatively secure against most financial shocks.”
A: “I am allergic to ‘rules of thumb.’ Personal finance is and should be personal. It is like a dress in that it should fit you well — one size does not fit all. My general recommendation is to try to do what is best for you, which typically includes saving as much as possible.”
A: “There are lots of good rules of thumb for budgeting. First, save at least two months of living expenses in a safe, liquid asset (like cash) in case of an emergency. This will make it so you don’t rely on credit card debt or other high interest loans. Then maximize the employer-matched portion of any retirement plan. Then supplement your retirement savings through other tax advantaged accounts, such as the employer plan, a traditional IRA, a Roth IRA or an FSA, up to 15% of your income. If you have leftover savings, take your age as a percent (for example, 30 years old = 30%) — that should go into investments with safe returns (paying down the principle on loans or purchasing bonds), and the rest should go into riskier, high-reward investments like stocks.
Approaching retirement, you should aim to save about 25 times your expected annual expenses past Social Security and any other defined benefit payments, a number that assumes a 4% payout rate. All of this is standard advice for standard life situations, but if you need help along the way, look for fee-based advisors who would agree to be a fiduciary.”