In 2012, a nutrition study found that when people are offered the same type and portion of food cut into bite-size pieces rather than whole, they tend to eat less and report being more satisfied with their meals. The 50-30-20 rule created works off of the same principle: if you “cut up” your income before receiving it, you can invest it in ways that better meet your current needs and passions, support your future goals, and position you to be financially responsible.
Money is consistently ranked as the most significant source of stress among adults, so it’s not surprising that budgeting might be anxiety-provoking. However, using this rule of thumb to guide your spending plan helps you to think about what you need, value, and want in the present and future. Carving up our income before we get our hands on it is an excellent way to steer us away from the financially-dangerous “scarcity mindset” that a lack of planning can cause.
How big is your ‘pie’
The first step to carving up your “income pie” is, well, first determining how large that pie is. After-tax income is your “disposable income;” that is, what’s left for you after taxes have taken the first bite.
If you’re on a salary, don’t be fooled into thinking that the original figure you agreed to when you first got your job is what you actually take home—that’s actually your pre-tax income. If you’re a freelancer or have a less consistent means of making money, try planning based on your average gross income by averaging your post-tax earnings for the past six months or so.
Once you’ve pinned down a figure for your after-tax income, whip out your proverbial pie slicer…
How to use the 50-30-20 rule
The 50-30-20 rule teaches us to divvy up our after-tax income into three categories:
50% for essentials
Try to limit your spending on essentials to 50%. In this category, include everything you can’t live without — food, insurance, housing, transport, basic clothing needs, utilities, healthcare, etc.
Considering inflated housing prices, tuition, and other costs compared to relatively stagnant wages, spending so little on the necessities may seem like (and may actually be) a pipe dream for many. However, if you can keep your spending on the things you need for day-to-day living around 50%, you’ll be in excellent shape to dedicate the other half of your income to your future and to fun.
Get creative as you consider how to limit your costs — could changing up your diet, finding a roomie, switching utilities providers, or popping tags at your local Goodwill help you reach this goal?
30% for your all-important flexible funds
Around 30% of your income should be dedicated to flexible spending and your all-important ‘fun fund’. This category is dedicated to the money you spend on the things you want. Having a pair of Converse in every color, inviting your best friend out for beers, or traveling to your dream destination certainly can make life a bit more enjoyable.
But, treating yourself responsibly is also a good way to stay on track with your more serious financial goals. Having a fun fund can prevent you from feeling impulsive and deprived, help you reconsider purchases, and even inspire creativity. When we use tools like a fun fund to approach money from an abundance mindset, we tend to make better decisions.
So, for the sake of your financial health, make sure you invest some part of your income in things which make you happy.
20% for personal financial goals
The underlying goal of budgeting is gaining financial freedom. As such, we must dedicate a part of our income to paying off debts and saving. When deciding between paying off debt or saving, there is no simple, universal answer. You have to consider a number of factors including interest rates, saving goals, and emergency funds.
First, concentrate on how big of an emergency fund you might need. Rainy day savings can prepare you for the unexpected and prevent you from falling into debt traps.
Next, consider how to further divvy up the remainder of this 20% of your income by looking into your debts and their respective interest rates. Balance your savings and debt payments so that you’re not paying more interest than you’re earning or defaulting on any loans. This often means paying off credit cards first, considering personal loans, and refinancing student loans.
Adjust the 50-30-20 rule
But…what if you’ve crunched the numbers and you simply can’t be faithful to the 50-30-20 rule?
This is an unfortunate reality for many because of the imbalance between the cost of living and wages. What if you live in a dangerous neighborhood, so you need to spend more on transport to get you home safely? What if you live in an expensive area because of work and lower-cost rentals are not an option? Or you have high health or family care expenses?
If you can’t perfectly mold your life into these proportions, don’t get discouraged. Instead, consider how you can adjust these percentages to remain faithful to the principles rather than the hard and fast rule.
While the 50-30-20 rule is great starting point, if your situation necessitates that you bend those portions to make life possible, you can still be in great shape, because you’ll be investing in your present needs and passions as well as planning for your future. To make your financial diet healthier, consider adapting the 50-30-20 rule to your needs to help you keep your portions in check!
