The 50/30/20 Rule
No matter how much money you earn, in order to be financially independent, spending has to be tracked.
The 50/30/20 rule is a simple technique that may help you to achieve financial independence. By dividing your spending into 3 categories, you can pay your bills, work toward your financial goals, AND continue to enjoy your lifestyle.
The 50/30/20 rule suggests that:
- 50% of your income should go towards your needs. This includes housing expenses, food, transportation, childcare, etc.
- 30% of your income should go towards things you want like travel, restaurants, entertainment, and luxury products, and
- 20% of your income should go towards achieving your financial goals. This includes debt reduction, savings, and investments.
These guidelines can be adjusted slightly depending on your current situation, however the strategy is most effective if you adhere as closely as possible to the 50/30/20 rule. If you find your needs cost more than 50%, find ways to reduce them. If your wants cost more than 30%, spend less. And if you save more than 20% - well great! There’s no limit to how much you should save.
To obtain financial independence, it is important to have a financial plan including a system to track spending.
To use the 50/30/20 rule, first calculate your after-tax income. If you share your finances with a partner, include their after-tax income too. Multiply the after-tax income by 50%. This is the amount to allocate towards your needs, such as:
- Mortgage or rent payments
- Vehicle loans and transportation costs
- Insurance premiums
- Food and household supplies
- Utilities
- Phone/Internet
- Essential clothing and footware
- Childcare and other child-related costs (if applicable)
To determine the amount to allocate towards your wants, multiply the after-tax income by 30%. Wants may include:
- Cable/streaming providers
- Luxury clothing and footware
- Luxury vehicles
- Restaurants including take-out
- Travel
- Upgraded phone/internet
- Personal care (spa, grooming, etc.)
- Entertainment, sports, activities
- Books, toys, games, equipment, etc.
Next, multiply the after-tax income by 20%. This is the amount to allocate towards savings (including emergency fund), reducing debt, and investing.
An effective way to keep on track, is to set up automatic withdrawals from your bank account. For example, have the allocated portion of your income earmarked for savings go directly into savings plans (i.e. HISA, TFSA, RRSP, etc.) and/or debt reduction.
A key to financial independence is to make a plan and consistently follow it.
Spending responsibly is one more step towards obtaining your financial goals.
This article is provided for information purposes only. Although the content is believed to be reliable when posted, Stonebrooke Asset Management cannot guarantee this information is current, accurate or complete and does not assume any liability. The information is not intended to provide any insurance, financial, legal, accounting or taxation advice and should not under any circumstances be relied upon without consultation about your specific situation. The information is subject to modification and updating from time to time without notice.