Understanding the 50/30/20 Budget
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NerdWallet recommends the popular 50/30/20 budget. In it, you spend roughly 50% of your after-tax dollars on necessities, no more than 30% on wants, and at least 20% on savings and debt repayment.
Over the long term, someone who follows these guidelines will have manageable debt, room to indulge occasionally, and savings to pay irregular or unexpected expenses and retire comfortably.
Allow up to 50% of your income for needs
Your needs — about 50% of your after-tax income — should include:
Minimum loan payments. Anything beyond the minimum goes into the savings and debt repayment category.
Child care or other expenses you need so you can work.
If your absolute essentials overshoot the 50% mark, you may need to dip into the “wants” portion of your budget for a while. It’s not the end of the world, but it’s a good idea to adjust your spending.
Even if your necessities fall under the 50% cap, revisiting these fixed expenses occasionally is smart. You may find a better cell phone plan, an opportunity to refinance your mortgage or less expensive car insurance. That leaves you more money to work with elsewhere.
Leave 30% of your income for wants
Separating wants from needs can be difficult. In general, though, needs are essential for you to live and work. Typical wants include dinners out, gifts, travel and entertainment.
It’s not always easy to decide. Are organic groceries a want or a need? How about your gym membership? Decisions vary from person to person.
If you're eager to get out of debt as fast as you can, you may decide your wants can wait until you have some savings or your debts are under control. But your budget shouldn't be so strict that you can never buy anything just for fun.
Commit 20% to savings and debt repayment
Use 20% of your after-tax income to put something away for the unexpected, save for the future and pay off debt.
Make sure you think of the bigger financial picture — that may mean two-stepping between savings and debt repayment to accomplish your most pressing goals.
Here’s a guide to ordering your financial priorities:
Start by building an emergency fund of at least $500 — enough to cover small emergencies and repairs — so that unexpected bills don’t push you further into debt.
Contribute enough to get the maximum 401(k) match, if your workplace offers that program. It's free money, the 401(k) has tax breaks, and it’s important to start saving for retirement as early as possible to let compound interest work its magic.
Pay down debt, focusing on high-interest credit card debt, personal and payday loans, title loans and rent-to-own payments. High interest rates can mean you end up repaying two or three times what you borrowed.
Get on track for retirement. Aim to save 15% of your gross income; that includes your company match, if there is one.
Beef up your emergency fund and aim to eventually have three to six months' worth of living expenses.
Pay down lower interest rate debt, such as auto, student and home loans.