This simple formula will transform your financial life
Read: 5 minutes
Managing your financial life isn't always easy.
So wouldn't it be nice to have a simple formula that could keep you on track economically, and help make sure you're budgeting, saving, and spending wisely?
The good news is it exists—and it's called the 50-20-30 rule (or the 50-20-30 budget).
Essentially, this rule suggests that you put 50 percent of your income toward your required bills (i.e. utility fees and rent); 20 percent toward savings; and 30 precent toward your wants (i.e. a new car or fancy gym membership).
“The 50-20-30 budget is a good rule of thumb because it gives people a foundation for where their money should go," says Bill Schretter, a certified financial planner and head of the fee-only financial planning firm Life-Legacy Services.
But in order for this magic formula to work — and ultimately give you a healthy, balanced outlook on money — the 50-20-30 rule has to be customized and properly applied to your own circumstances.
Since this formula is meant to be a roadmap to steer you to financial health, Schretter offers a detailed look at the 50-20-30 rule, and explains how you can correctly put it into practice. And trust us, it's a lot easier than you think.
Define your true needs versus wants
According to Schretter, your “needs" begin with minimum debt payments on any current obligations you owe, such as credit card bills, a mortgage, car payment, or student loan. Needs also include household utilities, groceries, healthcare costs, as well as auto, life, and homeowner's insurance.
While the 50-20-30 rule calls for you to spend 50 percent of your take-home pay on these primary expenses, many people are guilty of considering some superfluous "wants" as "needs."
Do you really need that fancy — and expensive — smartphone? Probably not.
Bill Schretter, a certified financial planner
Anything that is not an absolute necessity, from streaming services to vacation travel, should be classified as a “want," Schretter suggests. You can also think of “wants" as anything that makes your life easier or more enjoyable, but isn't mandatory.
Admittedly, one person's definition of a “need" may differ from another person's since we all have varying standards of living and different interpretations of what we “need." However, the goal with the 50-20-30 rule is to cap your spending on “wants" at 30 percent of your total income.
“There's nothing wrong with having luxuries in life," Schretter says. “But we all need to have a healthy combination of needs, wants and savings. Otherwise, you can very quickly start to live beyond your means."
Go through your bank statement line by line and ask yourself if you need each purchase.
Customize or apply choice to the rule
If you're not already consistently saving, the idea of socking away 20 percent of your salary may sound daunting. Don't worry, you have some options.
Schretter calls 20 percent an ideal savings goal and notes that you can reach that savings target in various ways, such as making extra debt payments, putting money into an IRA, or via an employer match from your workplace retirement plan.
But how you prioritize — and plan to use your savings — is up to you.
While some people save money for a specific goal, like a down payment on a home, others use their savings to gear up for retirement.
Build an emergency fund
No matter what your financial end game is, you should have an emergency fund within your savings.
“If you don't have one, you're likely overspending in other areas and not really taking care of your true needs," he says. "You should be financially prepared for a serious illness or getting laid off."
As a rule of thumb, your emergency fund should have three to six months worth of bare-bones living expenses. Start by setting aside $25 to $50 each week. It may not seem like a lot at first, but it'll add up over time.
Determine whether you're spending out of habit
To get the most value of the 50-20-30 budget, it's also helpful to ask yourself if you're making default decisions about what to do with your money, or whether you're making proactive, conscious choices.
Maybe you're in the market for an automobile, and you've always bought the shiniest, newest model on the lot. Do you really need a brand new car, or can you opt for a used vehicle?
"Most of our spending – or overspending – is purely out of habit," Schretter says. "It's amazing how much wasteful spending we all have."
Schretter admits to falling into this trap, recalling a time when he and his wife couldn't figure out where all their money was going. By tracking their spending, they identified the culprit: eating out way too frequently.
Once they calculated how many extra dollars were being spent on fine dining, $10 glasses of wine, and 15 percent tips, they made a commitment to eat out less.
"Turns out, steak at home was just as good, but a lot cheaper than steak at a restaurant," he says.
Lynnette Khalfani-Cox is a Chase News contributor who focuses on personal finance and whose work has appeared in The Wall Street Journal, among other media outlets.