How to Create a Budget
A version of this article originally appeared on Learnvest.com.
When it comes to money, there is no shortage of ways to spend it: food, rent, gifts, medicine, clothing, education, technology, gym membership, gas…you get the picture. So when contemplating a budget, it’s tempting to throw up your hands, say, “Forget it,” and hope for the best. Well, we have a simple solution for you: the 50/20/30 Rule.
No matter whether you’re a mom with two kids or a recent college grad working your first job, this rule will help you not only figure out how much you should be spending in each area every month; it will also tell you in what order you should be spending your money.
The 50/20/30 Rule Broken Down
The 50/20/30 Rule is easy because instead of telling you how to break down your budget across 20 or more different categories (who could possibly keep track of that?), it splits everything into three main categories:
1. Essential Expenses
No more than 50% of your take-home pay should go toward Essential Expenses, which are the expenses you need in order to maintain the fundamentals of your life: shelter, food, heat, etc. Only four expenses go in this category: housing, transportation, utilities, and groceries.
2. Financial Priorities
At least 20% of your take-home pay goes to Financial Priorities, which are the goals that are essential to a strong financial foundation. These include your retirement contributions, savings contributions, and debt payments, if you have debt. You should make these contributions and payments after you pay your Essential Expenses, but before you do any other spending.
3. Lifestyle Choices
No more than 30% of your take-home pay should go to Lifestyle Choices, which are personal, voluntary, and often fun choices about how you spend your discretionary income. They often include cable, Internet, and phone plans; charitable giving; childcare; entertainment; gym fees; hobbies; pets; personal care; restaurants; bars; shopping; and other miscellaneous expenses.
While Lifestyle Choices are the last things you should buy in your budget, you should never feel guilty about that expensive purse or ordering a nice bottle of wine at dinner as long as you’ve taken care of your Essential Expenses and Financial Priorities first.
One Note About Retirement
As you might have noticed, the 50/20/30 Rule applies only to take-home pay. Any contributions you make to retirement before your paycheck hits your bank account are not included. For that reason, you are actually contributing more toward your Financial Priorities than this breakdown would suggest. But we urge you to keep that retirement money out of sight, out of mind!
If you are self-employed and don’t have your retirement contributions taken out of your paycheck before it hits your bank account, you’ll need to make sure you’re hitting your retirement goals, and that could mean contributing more than 20% of your income to Financial Priorities.