This often used budgetary rule of thumb states you should try to keep your necessary expenditures to 50% of your total income, your discretionary expenditures to 30%, and the remaining 20% of your income should go towards savings.
While this approach is definitely not a bad starting point for money management, it's far too broad and general, and even terrible advice for many financial situations.
Let me explain what I mean.
While this approach is definitely not a bad starting point for money management, it's far too broad and general, and even terrible advice for many financial situations.
Let me explain what I mean.
Let's say, for example, that you happen to be among the lucky few who have a high salary, say of $150,000 or more. So let's assume for simplicity's sake that your take home pay is around $100,000.
That does not mean that your housing, food, and other necessities should be half that, or $50-$60,000 per year or more.
That would be absurd, in fact.
By contrast, if you’re in the lower salary ranges, some of your necessary expenses might push the total past the 50% mark. For example, when we started out, I was the sole breadwinner, and my take-home was a mere $800 per month. Our rent alone was $350, and we had utilities,food, transportation, and college tuition as essentials to pay. They came to well over half of my earnings.
In today's dollars, if you make $35,000, your take home pay would be in the ballpark of $28,500. It's perfectly feasible that your rent and grocery bill, combined with your transport costs, utility bills and medical deductibles and co-pays would be more than $14,000, or 50% of your income. Heck, rent alone can easily cost that in some parts of the country.
Of course, it's to be hoped that this is a temporary situation that will ease because your earnings will rise. But it's actually not an uncommon scenario at all, particularly when young people are starting out. Or for older people facing job loss and low-salary replacement jobs in these economic times.
When it does occur, the necessities consume a higher percentage of the budget. Which leaves less income available for discretionary expenses.
So your budget might conceivably look more like 55-25-20 or even 60-20-20 during these times.
Notice, though, that the savings percentage does not decrease. That's because you should always cut the budget in the area of discretionary spending before you cut your savings.
That does not mean that your housing, food, and other necessities should be half that, or $50-$60,000 per year or more.
That would be absurd, in fact.
By contrast, if you’re in the lower salary ranges, some of your necessary expenses might push the total past the 50% mark. For example, when we started out, I was the sole breadwinner, and my take-home was a mere $800 per month. Our rent alone was $350, and we had utilities,food, transportation, and college tuition as essentials to pay. They came to well over half of my earnings.
In today's dollars, if you make $35,000, your take home pay would be in the ballpark of $28,500. It's perfectly feasible that your rent and grocery bill, combined with your transport costs, utility bills and medical deductibles and co-pays would be more than $14,000, or 50% of your income. Heck, rent alone can easily cost that in some parts of the country.
Of course, it's to be hoped that this is a temporary situation that will ease because your earnings will rise. But it's actually not an uncommon scenario at all, particularly when young people are starting out. Or for older people facing job loss and low-salary replacement jobs in these economic times.
When it does occur, the necessities consume a higher percentage of the budget. Which leaves less income available for discretionary expenses.
So your budget might conceivably look more like 55-25-20 or even 60-20-20 during these times.
Notice, though, that the savings percentage does not decrease. That's because you should always cut the budget in the area of discretionary spending before you cut your savings.
But my biggest issue with the 50-30-20 rule is that I think the savings percentage in is just too conservative for those in higher income brackets.
After all, someone bringing home $100,000 should be able to live comfortably on a lot less than $80,000 and save more than $20,000.
A more prudent approach than sticking to a 20% rule is to increase the savings percentage of your budget as much as possible as income goes up, and to keep the other costs to conservative levels, so their share of your earnings actually goes down.
That way, you’d ensure that you are living well beneath your means and are well situated to to cope with any unexpected financial crises that may befall you.
It's savings, after all, that help us weather those unpleasant occurrences. They sure did that for us. You can read about the budget curve balls we've experienced in my blog about the topic.
After all, someone bringing home $100,000 should be able to live comfortably on a lot less than $80,000 and save more than $20,000.
A more prudent approach than sticking to a 20% rule is to increase the savings percentage of your budget as much as possible as income goes up, and to keep the other costs to conservative levels, so their share of your earnings actually goes down.
That way, you’d ensure that you are living well beneath your means and are well situated to to cope with any unexpected financial crises that may befall you.
It's savings, after all, that help us weather those unpleasant occurrences. They sure did that for us. You can read about the budget curve balls we've experienced in my blog about the topic.
Beyond that, there's the issue of achieving financial freedom some day. That's the ultimate goal of any budget plan, after all, and I think the 50-30-20 plan falls short in this regard.
Saving 20% of your income is a great starting point. But if your expenditures are always rising to meet your income whenever it goes up, that invariably puts you on a treadmill to perpetual financial dependence.
You have a far greater chance of actually achieving some level of financial security if you apply only a modest amount of a raise to lifestyle changes, and putting most of it towards savings,
In that scenario, you would not necessarily scale up to a more expensive house or apartment, or a luxury car. And you also wouldn't suddenly start spending more on food or utility bills or clothing just because you could afford to do so.
No, those costs would remain constant, so, with your higher income, your budget numbers might look more like 45-25-30, for example. And it would be an absolutely painless savings increase since you would not have to tighten your belt in any way.
So, here's my advice. Use the 50-30-20 rule mostly as a very loose guideline to get you started on a budget. But always be looking to increase the savings portion of the rule whenever you can.
That's the ticket to financial health and eventual freedom.
Here’s an article on the matter that goes into greater detail.
Saving 20% of your income is a great starting point. But if your expenditures are always rising to meet your income whenever it goes up, that invariably puts you on a treadmill to perpetual financial dependence.
You have a far greater chance of actually achieving some level of financial security if you apply only a modest amount of a raise to lifestyle changes, and putting most of it towards savings,
In that scenario, you would not necessarily scale up to a more expensive house or apartment, or a luxury car. And you also wouldn't suddenly start spending more on food or utility bills or clothing just because you could afford to do so.
No, those costs would remain constant, so, with your higher income, your budget numbers might look more like 45-25-30, for example. And it would be an absolutely painless savings increase since you would not have to tighten your belt in any way.
So, here's my advice. Use the 50-30-20 rule mostly as a very loose guideline to get you started on a budget. But always be looking to increase the savings portion of the rule whenever you can.
That's the ticket to financial health and eventual freedom.
Here’s an article on the matter that goes into greater detail.
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