The best budgeting rule of thumb
Everyone is different. Personal finance is personal. There is however some general rules of thumb that work well when it comes to creating some good savings habits and maintaining a good budget. Let’s take a tour of those and I’ll offer my take.
The 50/30/20 Rule
- 50% of your net income goes towards needs.
- 30% of your net income goes towards wants.
- 20% of your net income goes towards savings and debt repayments.
Popularized by Harvard bankruptcy expert Elizabeth Warren, she suggests this approach will provide an appropriate level of balance with your money.
- 50% needs include rent/mortgage, groceries, utilities, insurance and other essentials.
- 30% wants may include travel, dinner out, events, festivals, other.
- 20% savings and debt repayments also include emergency funds and retirement savings.
I like this rule because it is simple. You don’t need much work in the form of a spreadsheet to figure out where all your money should go.
The problem I have with this rule is I believe it’s difficult for most adults to distinguish a want versus a need. The lines are blurred between the 50% and the 30%. I need a car to get to work efficiently each morning. More than one of my fellow co-workers has suggested in recent months I get a new car – after comments to me in the parking lot such as “that thing still runs?”
Yes it does.
What might be a need for someone is a want for someone else. Clothing is a need. Maybe some nice clothing is a need. Lots of new clothing every week is a want. You get the idea.
What would I suggest instead?
The best budgeting rule of thumb – just save 10% net income (or more) and never stop.
Simple. Just save 10% (or more if you can) of your net income every month.
Effective as well.
Start saving early. Keep saving. Don’t stop. Then you figure out what you can afford from there.
What you can afford from there probably includes:
- Short-term debt obligations
- Dinner out
Start with your net income, calculate 10% of that, siphon that 10% into savings and long-term investments, and don’t ever spend it until decades from now. That’s it.
The beauty of this plan is you don’t have to worry about messing up needs with wants. You don’t have to worry about finding 20% savings amongst everything else. As David Chilton so nicely popularized it years ago “just pay yourself first” and everything else will fall into place.
You can do this by setting up automatic bill payments or transfers to your savings accounts or investment accounts each week or month. You can decide what to invest in later. If you’re a newbie to investing, you can check out this post.
The saving “more if you can” comes in if/when you get a bonus from work, as your income grows over the years, as you reduce various expenses in your life like mortgage payments or car payments, and so on.
Saving 10% off your net income means you get into the habit of stashing the cash.
Assuming you start with $1,000 in the bank, and your net income is more than $30,000 per year throughout your career, $3,000 per year saved for 40 years at a modest 6% rate of return will create a portfolio more than $500,000.
As long as you pay yourself first, and you continue to do so for decades on end, your budget will stay nicely intact and you’ll have a tidy nest egg to retire on far sooner than most.
What’s your favourite budgeting rule of thumb?
I like this way of doing it. It allows you to focus on enjoying life and not worrying about it (too much). Have a plan, save the amount to make that happen and spend the rest on what you need and what you enjoy. In my case I think 10% is a little low-maybe closer to 20%.
That’s the thing, put the money away first and have fun with what’s leftover – you don’t need to worry about saving if it already happened.
I think/know our savings rate is much higher than 10% net now but I wish I did that in my early to-mid 20s.
I prefer to say I save 20% of my net salary (or more). So 80/20. I won’t force myself to spend anything to be at exactly 20% net !
I did the exercice to split my budget / cashflow statement between “needs” and “wants” and the lines were blurry on some items. I was curious if I “respected” the 50/30/20. I ended up closer to 60/20/20.
“Needs” are mostly expenses from joint bank account and some personal expenses linked to work.
“Wants” are expenses I can decrease more easily without big changes (like changing house, selling car…). I don’t intend to do so, but it could be done to maximize RRSP, TFSA and RESP.
In needs: House, Groceries, Utilities, Kid expenses, Car, Bus, Professional-related expenses
In wants: Travel, Cellphone, Electronics, Restaurants, Gifts, Donations
Saving 20% of more of your net income is very good. Needs are also linked to our work needs. Those wants seem like big changes to me, i.e., selling a car.
We tend to put restaurants on the back burner if we have few funds to spend, that’s a very discretionary line item in our book – but an enjoyable one for sure. Thanks for the comment.
We use both in our house.
I use the the 50/30/20 Rule and my wife uses the 10% Rule.
When we first discussed budgets I had no problem distinguishing needs from wants and laying things out in their neat little boxes; my wife had a lot of questions! Life is more enjoyable for her when every penny she earns isn’t pre-earmarked. She plunks 10% down and is free to do whatever she wants with the rest.
Things like ‘dinner with the girls’ is a need for her, filed under ‘mental health’ but it also provides me with an evening at home to watch classic kung-fu movies or pretend to be a handyman and fix something, etc. I attempt to negate the cost of that expense. If she spends $50 for a night out, then I better “save” $50 on my night in (e.g. learning something new/practical).
It works well — I enjoy the detailed approach, she enjoys the simplicity and perceived freedom.
Interesting exercise, a dual system.
My wife is very much on board with the 10% rule and based on what I wrote in my article, i.e., save bonuses, if any; save money as mortgage payments and car payments go down over time – we’re now above 20% net income saving. It look us a long time to get here, but it’s good now.
Thanks for sharing what works for you.
10% or more Good Rule. Save as much as you can as often as you can!
Yup. Start with 10%, then bank raises, increases, bonuses, as your car payments go down, as your mortgage payments, go down – and you’ll be in a great place. I wish I did this in my 20s. The 30s got much better. The early 40s, I’m doing this 🙂
After budgetting in different ways, we now have a system where we pay ourselves first for retirement , or better, Financial Freedom. Then the rest goes to a mix of needs and wants and a life happens fund. this is some sort of an emergency fund sitting in front of the real emergency fund.
Mental accounting… It works for us
Great work. We’ve fallen into the “save 10% AND more” camp for a few years now and that works for us. We spend our money with what is leftover after savings are tucked away – we have no remorse with that approach. Could we be saving more for our future? Of course, but we feel we have to enjoy life too. Nice dinners out. Travel. Sporting event tickets. Festivals.
We definitely have an emergency fund.