In 2005, Jake Gyllenhaal played a US Marine in the Gulf War drama, Jarhead. During the boot camp opening scene, Gyllenhaal’s character regrets his enlistment, and the drill instructor rather aggressively asks him why he’s even there. Gyllenhaal’s character unwisely responds, “Sir, I got lost on the way to college, sir!”
Sometimes, we just need a little structure in our lives. The military isn’t the answer for everyone, but we all infuse structure into our live somehow. You often hear people say, “I’ve got to get back into a routine,” because daily structure reduces anxiety and creates efficiency. The same is true for our finances, and we call that structure a budget.
I have written previously about the importance of budgeting but never offered any guidance on practical implementation, so today I will discuss the 50/20/30 Rule. I’m no fan of financial fads, but this concept can be very helpful when starting the budgeting process for the first time. The idea is that you spend 50% of your net paycheck on fixed monthly expenses, 20% on savings goals, and 30% on variable monthly expenses. Here is a quick breakdown of each category:
50% Fixed Expenses: About fifty percent of your take home pay should go toward fixed monthly expenses. This category includes your mortgage payment, car note, utilities, daycare, memberships, tithing, etc. These amounts are predictable and recurring, so they should be easy to identify. If you need to reduce your overall budget, this category is a good place to start because you get hit with these expenses every single month.
20% Financial Goals: The next twenty percent of your take home pay should go toward savings and other financial goals. This category includes retirement savings but also extends to creating an emergency fund, paying off student loans, saving for a trip or new vehicle, and setting aside money for your kids’ college. Anything you are putting money away for is included in this category.
30% Variable Spending: The last thirty percent goes toward everything else you pay for on a monthly basis. Some of these items will be for essentials like food and transportation, but entertainment and travel are also included in this category. Variable spending is a bigger allocation than financial goals because it includes more items, but notice the order. Financial goals come before variable spending because you have to make your financial goals a priority.
It’s called the 50/20/30 Rule, but it should really be the 50/20/30 Suggestion. For example, if you make $1M a year, hopefully, your fixed expenses will be less than $500k for the year, and your savings will be greater than $200k. Conversely, if you make $20k a year, you will probably have to spend more than $10k on fixed expenses and may not be able to save $2k throughout the year. The breakdown just gives you some guidelines to think about when you are examining your monthly expenses.
Also, remember that these calculations are based on take home pay, so you may already be contributing toward retirement through a company sponsored plan. In which case, your total savings would be more than 20%, but that’s ok. Since financial goals encompasses much more than just retirement savings, going over 20% may be appropriate.
Finally, to make the most of this budgeting tool, automate as many of these items as possible. Your fixed expenses will be the same each month, so set them to auto draft. You will never miss a payment, and you can save yourself the mental energy of having to remember to write a check each month. Your financial goals can also be automated: If you are contributing to an IRA, set it to auto deposit, and if you are saving for another short-term goal, open another account and have the money automatically transferred each month.
A personalized budget will not create itself. You still have to take time to analyze your expenses and see where your money is going. But hopefully the 50/20/30 Rule will give the process some structure and help you get started.
Disclosure:
Josh Norris is an Investment Advisory Representative of LeFleur Financial. Josh can be reached at josh@LeFleurFinancial.com.