Saving money, building capital, maybe even a small fortune? This is possible with the 50-30-20 rule, regardless of your income! You keep track of your finances and create an optimal budget. This way, you know how much you can spend on what and have a fixed amount for long-term wealth building. It requires consistent planning and financial discipline. We’ll show you how the 50-30-20 rule works and how to optimize your finances with it…
What is the 50-30-20 Rule?
The 50-30-20 rule is a simple formula for saving money and building capital, regardless of the level of income. The available net income is allocated to three different-sized expenditure and savings categories:
- 50 percent for fixed costs and essential expenses
- 30 percent for leisure and personal needs
- 20 percent for savings and debt repayment
The goal of the 50-30-20 rule is to provide a better overview of one’s finances. Monthly budgeting is organized to cover expenses and make investments.
50-30-20 Rule: How Should I Allocate My Salary?
According to the 50-30-20 rule, you should allocate your net income as precisely as possible into the three categories. The following list shows which expenses fall into each category:
Fixed Costs (50 percent)
The largest items are the basic expenses that are incurred each month. These include primarily:
- Rent
- Electricity and gas
- Insurances
- Contracts for internet, television, telephone, and smartphone
- Groceries
- Refuel
Calculate exactly what you need for this. In order to comply with the 50 percent limit, a cheaper apartment or changing providers can help with contracts. Price comparison portals can help here.
Personal Needs, Free Time, and Desires (30 percent)
These costs are not essential but cover personal needs. These are expenses for leisure activities and participation in social life. They are also called leisure expenses or lifestyle costs. This includes:
- Dining out
- Travel
- Shopping and clothing
- Cultural activities
- Hobbies
- Vacation
- Consumer electronics
You decide what you should spend the money on. You can and should treat yourself to something. It is important that the costs do not exceed 30 percent of the monthly income.
Savings Share (20 Percent)
20 percent is not spent on consumption but goes into the savings account. The third share according to the 50-30-20 rule can serve various purposes:
- Paying off debts
- Saving and building wealth
- Investing in stocks or ETFs
- Reserve for emergencies
- Private pension provision
- Preparing for a real estate purchase
Paying off debt takes precedence over savings goals. It is this saved 20 percent that allows you to build long-term wealth. With 1,500 bucks net income, you invest 300 bucks per month.
Sample Calculation For The 50-30-20 Rule: $2000 Net Income
The example shows the effectiveness of the 50-30-20 rule. With an assumed net income of $2000 per month, the breakdown for the budget looks like this:
- 50 percent fixed costs: 1000 bucks
- 30 percent Personal expenses: 600 bucks
- 20 percent savings: 400 bucks
Tips For The 50-30-20 Rule
After all this theory, it’s time to get practical. To make the rule work, you ultimately need to review your fixed costs and expenses for potential savings. You can achieve this by following these tips:
01. Reduce Fixed Costs
Regularly review your basic expenses. Can you really afford your rent? Is there a cheaper provider for electricity or gas? Are all the insurance policies necessary? Use consumer and comparison portals. A separate household account, to which you transfer 50 percent of your income by standing order, can be helpful. It’s important to differentiate between essential needs and expenses that enhance your life but are not necessary.
02. Keep a Household Budget
You can get a good overview by keeping a household budget. In it, you record current and future expenses. This allows you to track changes (compared to previous months) and plan your budget. Thrifty individuals may discover some savings potential in the process.
03. Plan Your Expenses in Advance
Some expenses are unexpected, but many can be foreseen. Is your fridge ten years old, or is your car sputtering? Plan for such expenses in advance. Set aside a specific portion of your savings or reduce your personal spending for a period of time to have extra money available.
04. Build an Emergency Fund
Long-term investments and returns are an important part of the 50-30-20 rule. However, initially, your focus should be on building a financial emergency fund. A rule of thumb is to set aside enough money to cover your living expenses for 3 to 6 months. This way, you’re prepared for emergencies and have a financial cushion. Set up a standing order to a savings or money market account until your emergency fund is reached.
06. Avoid Exceptions
Do not make exceptions to the 50-30-20 rule. Your net income is divided into these categories, including bonuses or holiday pay. If you keep making exceptions or shifting boundaries, the system won’t work.
07. Maintain Your Savings Rate
A common mistake is to reduce the savings rate when you facing budget issues. Instead, consider reevaluating your other expenses. It might require making some small sacrifices or cutting back on certain aspects of your lifestyle, but in the long run, it will help you achieve financial freedom. Don’t cut corners when it comes to saving!
50-30-20 Rule: An Alternative to Saving
The 50-30-20 rule is a widely used and popular option for personal financial optimization and long-term wealth building – but it’s not the only option. Various alternatives bring order to financial chaos with different expense categories or different allocations. What almost all of them have in common is the need for a defined savings and investment rate.
In other words, at the end of the month, there must be money left over. If you spend your entire income, there will be nothing left in the long run. In that case, there are only two options: increase your earnings or reduce your expenses.
The 60-30-10 Rule As An Alternative
An alternative that is similar to the 50-30-20 rule is the 60-30-10 rule. With this rule, you divide your income into three different accounts for different purposes.
01. Consumption (60 percent)
The majority of your income goes towards consumption. This part includes all your monthly fixed expenses, as well as additional spending for leisure or other purchases. From this account, you cover all your ongoing costs and maintain your livelihood.
02. Investment (30 percent)
A relatively large portion of 30 percent is allocated to investments in this concept. This includes direct financial products and investments in stocks, as well as personal development to enhance your skills and knowledge.
03. Savings (10 percent)
According to the 60-30-10 rule, the last ten percent is your savings rate. From this, you set aside some for short-term emergencies and build the aforementioned emergency fund.
Advantages of this method:
You invest a large part of your income and can therefore make significant investments over several years. But there is also a big catch: you only have 60 percent of your income left to live on.
The 50-30-20 Principle – Also For The Self-Employed
The 50-30-20 rule is suitable for every phase of life and every professional situation. In an employment relationship, it is particularly simple: the net income remains the same every month.
But the formula also works for the self-employed: You calculate your average net annual income and divide it by twelve. Do not forget to include in the fixed costs the portion of the irregular charges.
There are, for example, tax advances and additional payments. Even months with low sales can be compensated in this way and you are spared any nasty surprises.
