October 12, 2020
Tagged As: Personal
If you’ve decided to start getting serious about managing your money, making a place in your budget [link to Budget article] for savings will pay off. Just how much it pays off depends on how much you’re able to save, where you put it, and how long you are able to let it grow with interest.
First things first, how much of your money should go toward savings? There’s an easy way to figure it out: the 50/30/20 rule.
Budgeting for needs, wants, and savings with the 50/30/20 rule
The 50/30/20 rule is a simple, practical rule of thumb for individuals who want a budget that is easy, yet effective, to implement. It offers guidelines for enjoying your income while putting savings on autopilot.
Humans are fallible—sometimes we just need guidelines. If you struggle making sense of a sea of budgeting systems and apps, consider the 50/30/20 rule. Developed by Elizabeth Warren, a presidential candidate, senator, and an expert in bankruptcy law, the 50/30/20 rule states that your after-tax income should be roughly divided three ways:
- 50% to needs
- 30% to wants
- 20% to long-term savings
Here's a tool to help you see how much of your monthly income should be used in each category according to the rule.
People define their needs in vastly different ways, however, there are several things we can easily agree on:
- Housing: Rent, mortgage, homeowners insurance, property taxes
- Transportation: Car payment, insurance, gas, public transport passes, parking
- Short- to mid-term savings goals: Down payment on a car, a new roof, replacement furnace
- Health care: Insurance premiums, deductibles, prescriptions
- Insurance: Auto, life, home, health
- Utilities: Gas, water, electricity, internet, cell phone
- Loan payments: Credit card debt, student loans
Note that the necessities come in two varieties: routine bills and predictable goals. Some expenses you will pay regularly, and others (like a new roof), you must anticipate and set money aside for.
While the necessities are easy to agree on, wants are subjective and personal. The 50/30/20 rule encourages you to be explicit about your wants. Give yourself permission – within a reasonable set of constraints – to spend some of your money on things that make your life enjoyable:
- Gym memberships
- Online subscriptions
- Cable TV
- Take out or delivery
The key is to be honest with yourself about how much your wants overlap with your needs, and to categorize them correctly. Sure, everyone needs clothes, but most of us would admit that shopping for new clothes can often be frivolous.
There is no financial habit – especially for young adults – as important as saving. Unsurprisingly, it's also the hardest. To save is to delay gratification. Make the decision today, whether you follow the 50/30/20 rule or not, to save a significant portion of your income for:
- Rainy days, and
The former is hard because, with our money, we're optimists. What could go wrong? Retirement, on the other hand, is difficult because it can seem so distant (surely I can save for retirement when I get a better job, right)?
Make saving automatic
First, for emergencies, set aside a portion of your income in a savings account – an account with a limited amount of withdrawals and no checkbook. A savings account helps you mentally earmark your money, making it less likely you'll withdraw it for spurious reasons. With a little protection in place, if disaster strikes, you can still transfer the funds to a checking account easily enough.
One of the great secrets to saving is finding ways to make it automatic. Don't put yourself in the position of deciding how much to save with each paycheck. Make the savings decision once, and ride it as long as possible.
At Hills Bank, we’re making automatic saving easier than ever with Savers Club and Goals.
- Savers Club: Designate an amount to save each week for a year, in $5 increments from $5-125. The amount will transfer weekly from your debit/other account to this special savings account. After you’ve made the equivalent of 50 payments, we’ll make your last payment for you! Click to learn more.
- Goals: Available in Hills Bank Online for your desktop or smartphone, Goals lets you automatically set aside money for rainy days, a new car, a vacation, or just about anything you can think of. You don’t need a banker to set it up: you can start saving right now!
Contribute as much as you can to a 401(k) or individual retirement account (IRA)
If you're employed, it's possible your employer offers a 401(k) and maybe even matches some of your contribution. If your employer matches 3% of your salary, for example, make sure you contribute at least 3%. Otherwise, you're leaving money on the table. But don't stop there; contribute much more money where possible. Your future self will thank you.
Investment products are not a deposit, not FDIC insured, not insured by any federal government agency, carry no bank guarantee, and may go down in value.
Some employers, if they support direct deposit, will let you split your paycheck between accounts. This payment method is also a nice way to put money into a savings account automatically.
Calculate how a savings account can add up
Finally, some people frown on saving money, calling it unnecessarily severe, or self-depriving. Resist that feeling. Saving is not about amassing a pile of money – it's about security and preparing for a time in your life when you will quit working, making it as enjoyable as possible. Saving is gratifying. It will instill confidence and self-respect.
Like all budgeting methods, the 50/30/20 rule is not perfect, and shouldn't be applied as-is to every budget. Saving 20% is a huge improvement for some people. For others, it's low. If you're a high-income earner, for example, you should consider saving (and investing) much more than 20%, especially if you intend to travel. On the other hand, if you’re struggling to make ends meet, consider spending less than 30% on wants. Resist the temptation to compare yourself to others. Make adjustments. Place an emphasis on your long-term goals.
Note: The 50/30/20 rule is not appropriate for individuals who are in deep personal debt (unsecured debt). To avoid bankruptcy, a default, or long-term credit damage, dedicate as much of your income as possible to paying off credit card balances and student loans. Without neglecting your emergency fund, you may need something like a 75/5/20 rule until you've cleared your obligations.
The 50/30/20 rule is a simple, practical rule of thumb for individuals who struggle to budget. It offers guidelines for enjoying your income while putting savings on autopilot. If budgeting isn't natural to you – especially if you're young, and you've avoided deep debt – the 50/30/20 rule gives you permission to relax a bit and put savings on autopilot.