Finally, you reviewed your budget and determined how much money goes for home, car, entertainment, and retirement fund. But, what happens with other savings such as emergency? The main question is, how well your finance compare to the amount of money you could spend and save?
Elizabeth Warren—U.S. Senator from Massachusetts, developed a 50/30/20 rule for spending and saving. So, let’s how it actually works!
Calculate after-tax income
After-tax income is what’s left of your paycheck after taxes are taken care off, for example, local tax, state tax, income tax, and so on. If you have a steady paycheck, then you can easily calculate the after-tax income.
Look for any deductions and just add them back in. On the other hand, if you are self-employed, your tax-income is equal to your gross income. In this case, you’re responsible for paying quarter tax payments because you don’t have an employer to do it instead of you.
Your needs should be no higher than 50%
To follow the 50/30/20 rule, you must limit your needs to 50%. This involves bills, groceries, car payments, insurance, and any other expense you may have. However, you should make a difference between costs that are a necessity and your wishes.
Any payment that doesn’t cause significant inconvenience such as cable bill is a “want.” On the other hand, paying the electricity bill, or a mortgage is a “need.”
The “wants” should not exceed 30%
Who wouldn’t want to spend 30% of their paycheck on shoes, beautiful clothes, salon haircuts, and easting out in restaurants? Well, not so fat, remember how limiting we were with the previous category?
The “wants” we mention here don’t include lavish life, but essential life necessities, such as unlimited texting plan, or adding Netflix, or doing cosmetic repairs on your car. You would be surprised how much money you can spend on this category.
Even though this rule is tricky, it makes sense if you think about it.
Spend 20% on debt payment and savings
You should spend at least 20% of your paycheck on remaining debts or direct the money to savings or retirement account. For instance, if you have a credit card balance, the minimum payment is considered as a “need” and goes into 50% category. However, if you are able to pay something extra, then it goes to this category.
Also, mortgage and a car loan is a “need,” but if you can invest additional money, then it is accounted as debt repayment.