by Laura Shin, learn vest
When it comes to money, there’s certainly no shortage of ways for us to spend it—food, rent, retirement accounts, a down payment on a house, gym memberships, gifts … you get the picture.
In fact, it’s why LearnVest Planners are often asked one key question: “So where should my money be going?”
When it really comes down to it, the answer is different for everyone. You may be in a hurry to pay off debt, so you’re willing to spend less on eating out in the meantime. Or you might live in a city where rent is prohibitively expensive, so you have to allocate more of your paycheck to housing.
So what’s a budget-perplexed person to do? While we can’t give you a hard-and-fast rule for where to put your money, we did come up with a general benchmark to consider if you’re just starting to set up a budget: the 50/20/30 guideline.
Whether you’re a parent with two kids or a recent college grad working your first job, this 50/20/30 guideline can help you not only figure out how much you may want to allocate to each area every month; it can also help you determine the order in which your money can be allocated.
50/20/30 Broken Down
The 50/20/30 guideline can be easy to follow because instead of telling you how to break down your budget across 20 or more different categories (who could possibly keep track of that?), it splits everything into three main categories:
1. Fixed Costs
These are bills and expenses that don’t vary much from month to month, like rent or mortgage payments, utilities and car payments. We also include subscriptions, such as gym memberships and Netflix accounts, in fixed costs because you’re committed to paying them on a monthly basis.
When it comes to fixed costs, we generally suggest that you aim to keep your monthly total no more than 50% of your take-home pay.
Tip: If you’re trying to make more room in your budget, fixed costs can be a great place to trim. For example, are there any bills or subscriptions you could reduce or cancel entirely?
2. Financial Goals
Consider putting at least 20% of your take-home pay toward important payments or contributions that will help you secure your financial foundation. At LearnVest, we believe there are three essential goals everyone should strive for: paying down credit card debt, saving for retirement and building an emergency fund. But your financial goals can also include larger savings priorities like a down payment on a new home.
Tip: LearnVest Planners recommend automating your savings contributions and debt payments to help make sure you’re saving consistently—and to help ensure you don’t miss a payment!
3. Flexible Spending
Finally, consider budgeting no more than 30% of your take-home pay toward flexible spending. These are day-to-day expenses that can vary from month to month, like eating out, groceries, shopping, hobbies, entertainment, or gas.
We include groceries in flexible spending because even though food is a necessity in your budget, how you spend on food can vary. Some weeks you might eat out more, while others you may buy more groceries to cook at home. At LearnVest, our Planners often say that it doesn’t really matter what you spend your money on each month in this category, as long as you’re aware of your spending and not going over your total flex budget each month.
Tip: To determine your flex-spending amount, we recommend first subtracting your fixed costs and financial goal contributions from your take-home pay (the amount that hits your bank account after taxes and any 401(k) contributions). This way, you’ll know that the amount that’s left for flexible spending is truly yours to spend however you want.
Seeing 50/20/30 in Action
The 50/20/30 guideline is just that—a guide. It can be a helpful benchmark when you’re assessing where your money is going, but it can also be adjusted to your specific lifestyle and goals.
To better explain what we mean, let’s compare two hypothetical budgets—one for Molly and one for a couple, Sarah and Tim.
Molly is a 22-year-old recent graduate with her first job, working in Chicago. She has student loans, but she is still able to meet her student loan payment every month and contribute to a Roth IRA, plus pay all her bills.
Her income: $36,000 a year
Her take-home pay after taxes: $2,250 a month (we’re assuming 25% of her salary goes toward a combination of taxes and her 401(k) contributions)
Utilities (including phone and internet): $135
Gym and subscriptions: $75
Total: $1,100, which is about 49% of her take-home pay
Student Loan: $150
Roth IRA contributions: $200
Emergency fund: $75
Backpacking trip fund: $50
Total: $475, which is about 21% of her take-home pay
Flexible Spending: $675, which is 30% of her take-home pay
Because Molly is on a tight budget, her fixed costs are very close to the 50% limit. Still, she is able to make her student loan payment and even put 9% of her take-home pay toward retirement, where the money should have a long time to grow.
Sarah and Tim
Sarah and Tim are in their mid-40s and have two children nearing college age.
Their household income: $150,000 a year
Their take-home pay after taxes: $8,750 a month (we’re assuming 30% of her salary and her husband’s go toward a combination of taxes and their 401(k) contributions)
Car payment and insurance: $775
Utilities (including hone, TV and internet): $275
Total: $3,325, which is 38% of their income
Roth IRA contributions: $900
529 account contributions: $1,400
Family trip fund: $400
Emergency Fund: $535
Total: $3,235, which is about 37% of their take-home pay
Flexible Spending: $2,190, which is about 25% of their take-home pay
Sarah and Tim’s situation shows that you don’t need to stick hard and fast to the 50/20/30 guideline. The benchmark for fixed costs is “no more than” 50%, and Sarah and her husband have actually been able to keep them well below that threshold. They paid off one of their cars a while back and their mortgage payment is well within their means.
Because they’ve kept their fixed costs low, they are able to contribute to their kids’ 529 accounts. At the same time, they are on track to max out their Roth IRA contributions because saving for retirement is a higher financial priority for them than saving for their children’s college funds. That’s because you can borrow for a college education later if you need to, but you can’t borrow to cover retirement! Sarah and Tim are balancing their desire to save for their children’s future education without sacrificing their own retirement needs.
In order to make room for 529 savings, they have decided to limit their flexible spending to only 25% of their take-home pay.
One Note About Retirement
As you might have noticed, the 50/20/30 guideline applies only to take-home pay. Any contributions you make to retirement before your paycheck hits your bank account are not included. For that reason, you may actually be contributing more toward your financial goals than this breakdown would suggest. And you may find that it’s a good thing to keep that retirement money out of sight, out of mind!
(If you are self-employed and don’t have your retirement contributions withheld from your paycheck, consider contributing more than 20% of your take-home pay toward your financial goals, if you can afford it. This could help you make sure you’re contributing enough to stay on track for retirement.)
How the 50/20/30 Guideline Can Apply to Your Own Budget
If you’re just starting to put together a budget, the 50/20/30 Guideline can serve as a useful benchmark for how to divvy up your paycheck. When it comes down to it, though, how you spend (and save) your money depends on your specific goals and lifestyle.