The 50/20/30 Budget Rule

Rules of thumb can be very helpful when seeking some guidelines within which to work to accomplish a large task. Breaking things down into bite-sized chunks makes them easier to consume — so to speak.

The 50/30/20 budget rule of personal finance is one such example. It helps you to allocate your funds in the most effective manner possible and it helps you determine what categories are most important.

Let’s take a look at it in more detail.

Needs vs. Wants vs. Obligations

The basic premise of the 50/20/30 rule of budgeting states 50 percent of your after-tax income should be set aside to cover your needs. The next 30 percent should be apportioned to your wants and the final 20 percent should be applied to debt eradication and savings.

This, of course, leaves us to determine what constitutes needs vs. wants, as well as debt and savings obligations.

Needs

Everybody needs food, clothes and shelter.

In other words, anything you must have to survive and thrive counts as a need. Within this category will fall things like utilities, groceries, rent/mortgage payments, prescription medications, insurance coverages and your car — including its fuel and maintenance.

This can also include minimum credit card payments. After all, your credit score will be impacted negatively if you fail to make them. This, in turn, can make it difficult to get shelter, insurance and even employment.

Obligations

You should definitely consider saving to be an obligation. You owe it to yourself to provide the best long-term financial cushion you can comfortably afford. In fact, saving and investing to provide for your future needs is one of, if not the smartest things you can do with your money.

To that end, if you also have credit card debt, eradicating it as soon as possible improves your financial situation. Thus, anything you apply to debts over and above minimum payments should also come out of this 20 percent.

A free budget planner, like the one offered by Clarity Money, will help you figure out what the exact dollar amounts should be.

Wants

Here’s where a lot of people get sidetracked. Yes, you need clothes — but you don’t have to get them at Nordstrom, Saks Fifth Avenue or Neiman-Marcus. Target’s clothing will cover your body just as effectively.

Thus, that sweet cashmere sweater you saw at Saks falls into the “wants” category. Similarly, a used Toyota RAV4 will get you to and from work just as readily as a brand-new BMW X5. While a car can be a need, luxury cars like the BMW fall firmly under the heading of wants.

Both Whole Foods and Foodsco sell groceries.

Care to guess which is a want and which is a need? Basically, needs can also be wants, but wants are seldom needs.

Now with all of that said, feel free to indulge in whatever luxuries that 30 percent will permit. Maybe it’s saving for a dream vacation, driving a luxury car, or going on the occasional shopping spree. Whatever it is, cover your needs and your obligations first so you don’t go have to go into debt to satisfy them.

Working within the 50/30/20 budget rule you’ll find your needs, wants and obligations will usually be met. If any of its categories require you to spend more than their apportioned ratio, the rule will also help you figure out what to do to get things on track.

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