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The Easy Budgeting Rule: 50/30/20

There are many rules of thumb when it comes to personal finance, such as saving 10% of your gross salary for retirement or making a 20% down payment on a home.  If you want budgeting to be less painful, there’s the 50/30/20 rule that can make your life easier.

The rule is relatively simple: 50% of your after-tax income is allocated towards your needs, 30% is for your wants, and 20% is for saving and paying down debt. The great thing about this rule is how easy it is. Let’s take a deeper dive into how everything breaks down.

The first step, however, is to determine your net income. It’s the amount of your paycheque after all the deductions, such as Canada Pension Plan (CPP) contributions, employment insurance (EI) premiums, health insurance, and federal and provincial/territorial taxes. It’s common for your take-home pay to increase near the end of the year when the annual maximum amounts for CPP and EI are reached. Keep that in mind when you’re trying to calculate your net income.

You can try this income tax calculator to give you a reasonable estimate.

Set aside 50% for your needs

Once you’ve figured out how much you earn after tax, allocate half of it for your day-to-day needs. These needs include your mortgage or rent, utilities, groceries, transportation, and possibly childcare.

These are the expenses you’ll have no matter where you live or work. Mainly, you wouldn’t be able to live without food or shelter. The thing to remember is not to go over the 50% mark. If you do, look at how you can reduce some of those costs, such as finding a cheaper mode of transportation, getting the best mortgage rate, or finding less expensive auto insurance quotes.

Set aside 30% for your wants

If you think about it, 30% sounds like a pretty good amount for your wants. Dinner at a five-star restaurant every week? A first-class flight to Europe? A trip to the spa for a massage every month? Sounds nice, right? Maybe not.

Before you dream big, your wants aren’t just the best things in life. Your wants are the wireless bill, the expensive clothes you don’t need, dining out with your friends, the cable bill, the gym membership, and even the latte you buy every day on the way to work.

When you find yourself spending more than 30% on things you want, it’s time to look for ways to cut back. Switch to a cheaper wireless provider, buy less expensive clothes, cook ahead of time, so you don’t have to eat out as much, go to the gym more often to make having a membership worth it, and maybe don’t buy a latte (or two) every day.

If you’re able to get spending on your needs below 30%, you may be able to find some money for dinner at a five-star restaurant. It probably won’t be every week though.

Set aside 20% for saving and paying down debt

Finally, the remaining 20% should go towards saving and debt. If you want to pay off debt faster, you can designate a certain percentage of the 20% towards credit card debt or student loans. Since the interest rate on credit card debt is often higher than what the kind of return you can expect on investing, it makes sense to pay that down first.

If you don’t have any debt or you’ve managed to pay it all off, you can use the funds to build an emergency fund or save for retirement. Even if retirement may be decades away, you’ll end up with more in the future when you start saving early.

You can always allocate more than 20% of your money to savings and debt. Doing so will help you get out of debt sooner or possibly allow you to retire earlier.

The bottom line

The 50/30/20 rule is a simple and easy way to determine how much to save and spend. You can always make small adjustments to the percentage you spend or save in the three categories, but you don’t want to be spending more than 80% on your needs and desires. If that’s the case, it likely won’t be possible to save or pay down debt.

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