Some people are better at saving money than others. Those who are good savers generally know how to live within their means, and they tend to keep their living expenses low compared to their earnings. Those who aren't natural savers, by contrast, tend to fall into the trap of spending most, if not all, of their income on their basic needs. And then there are those who truly go overboard, spending more money than they bring home and racking up debt in the process.
No matter your age, it's important to start saving money for things like retirement, emergencies, and major life goals such as buying a home. Creating a budget can help you manage and keep track of your living expenses so there's money left over to help you meet your savings targets.
Taxes
The first rule of establishing a budget is figuring out your take-home pay. Remember, your salary is notthe amount you take home. If your job pays you $60,000 a year and you're in the 25% tax bracket, then you'll pay about $10,800 in taxes on that income, leaving you with $49,200. That's about $4,100 a month that you can put toward living expenses and savings. (Note that your tax bracket, also known as your marginal tax rate, is not the rate you pay on all your income. Your effective tax rate is generally much lower. See this article for more details.)
Housing
Housing is generally the average person's greatest monthly expense. It's best to keep your housing costs as low as possible, but under no circ*mstances should you allow more than 30% of your take-home pay to go toward housing. If you're a homeowner, that 30% includes not only your mortgage payment, but also your monthly property tax and homeowners' insurance payments as well.
The 50/20/30 rule
When creating a budget, you can list each and every monthly expense you incur as its own line item, or you can combine some of your expenses and follow what's known as the 50/20/30 rule. The benefit of the 50/20/30 rule is that it groups certain expenses together to make your budget easier to track. The 50/20/30 rule splits your living expenses into three main categories:
- Fixed costs that stay the same month after month, such as your rent or mortgage, car payment, and cable bill. Fixed costs should take up 50% of your income.
- Variable costs that can change from month to month, such as entertainment, groceries, and clothing. Variable costs should take up 30% of your income.
- Savings, which should take up 20% of your income
The 50/20/30 rule allows you to retain some flexibility in your budget while saving a nice percentage of your income. While you can always adjust these percentages to accommodate your circ*mstances, limiting your fixed costs to 50% of your income should leave you with enough money left over to save and cover your variable expenses. Along these lines, allocating 30% of your income to variable costs means you'll have a decent amount of wiggle room within that category alone.
Identifying essential costs
A big part of saving money is learning to distinguish between essential and non-essential living expenses. Essential living expenses are non-negotiable; you simply can't function without them. Examples include housing costs, auto insurance, and food. Non-essential living expenses include restaurant meals and fancy electronics, which may be nice to have but aren't necessary. Limiting your non-essential living expenses can help free up more of your income for more important things, like savings.
Growing your savings
Once you distinguish between your essential costs and those that are "wants" more than "needs," you can work on making changes that allow you to build your savings. While the majority of your income will probably go toward your living expenses, make sure your budget leaves you enough room to save money as well. Your first savings goal should be to put together an emergency fund with enough money to cover three to six months' worth of expenses. From there, you should work on saving for retirement. Many financial experts recommend saving at least 10% of your income for retirement, and the sooner you begin, the more time you'll have for that money to grow. You may start off by saving a small sum each month and increasing that amount gradually, but the key is to make saving a priority regardless of how much money you earn.
This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors. We'd love to hear your questions, thoughts, and opinions on the Knowledge Center in general or this page in particular. Your input will help us help the world invest, better! Email us at[emailprotected]. Thanks -- and Fool on!
We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
FAQs
How do you figure out a budget? that works for you. We recommend the 50/30/20 system, which splits your income across three major categories: 50% goes to necessities, 30% to wants and 20% to savings and debt repayment.
What is the 50/20/30 budget rule? ›
Those will become part of your budget. The 50-30-20 rule recommends putting 50% of your money toward needs, 30% toward wants, and 20% toward savings. The savings category also includes money you will need to realize your future goals.
What percentage of income should go to fixed expenses? ›
Fixed expenses 50%
These unchanging costs should stay within 50% of your monthly income. Choose housing, transportation, and monthly subscriptions you can afford to sustain without draining your wallet.
What percentage of income should be fun money? ›
You can tinker with this total as you like to find the right fit. But I suggest holding to 10% at a maximum. If yours is higher than 10%, you could probably stand to make your budget a little more specific. I recommend budgeting 10% of your monthly take home pay, after tax, for fun money.
What is the 70% income rule? ›
The rule states that you should allocate 70% of your income to monthly rent, utility bills, and other essential needs to improve your financial well-being. 20% of your income should go to savings. The remaining 10% can go towards your investments or to debt repayment.
What is the 50 30 20 rule for 401k? ›
Key Takeaways
The 50/30/20 budget rule states that you should spend up to 50% of your after-tax income on needs and obligations that you must have or must do. The remaining half should be split between savings and debt repayment (20%) and everything else that you might want (30%).
What is the 75 15 10 rule? ›
In his free webinar last week, Market Briefs CEO Jaspreet Singh alerted me to a variation: the popular 75-15-10 rule. Singh called it leading your money. This iteration calls for you to put 75% of after-tax income to daily expenses, 15% to investing and 10% to savings.
Is the 30 rule outdated? ›
The 30% Rule Is Outdated
To start, averages, by definition, do not take into account the huge variations in what individuals do. Second, the financial obligations of today are vastly different than they were when the 30% rule was created.
What is the 40 40 20 budget rule? ›
The 40/40/20 rule comes in during the saving phase of his wealth creation formula. Cardone says that from your gross income, 40% should be set aside for taxes, 40% should be saved, and you should live off of the remaining 20%.
What is the best income to expense ratio? ›
According to the rule, 50% of your take-home pay should be allocated to essential expenses (housing, food, health care, transportation, child care, debt repayment), 15% of pretax income (including employer contributions) gets invested for retirement and 5% of take-home pay is used for short-term savings (like an ...
For traditional retail banks, a cost-to-income ratio of around 50-60% is often seen as acceptable.
What is the ideal income allocation? ›
Our 50/30/20 calculator divides your take-home income into suggested spending in three categories: 50% of net pay for needs, 30% for wants and 20% for savings and debt repayment. Find out how this budgeting approach applies to your money.
What income are people happiest at? ›
Most people's happiness rises linearly with income, while about 30% of people are the "happiest," experiencing accelerating well-being once their earnings rise above $100,000.
How much money is enough to enjoy life? ›
The amount of R2 lakh per month should be enough for a comfortable middle-class life in a city in India. But then, our life does not stop at needs. There are wants and desires. You need more than R2 lakh a month for those looking for more comfort.
How much of salary should go to expenses? ›
50% of your net income should go towards living expenses and essentials (Needs), 20% of your net income should go towards debt reduction and savings (Debt Reduction and Savings), and 30% of your net income should go towards discretionary spending (Wants).
What is a good living expense ratio? ›
50% of your net income should go towards living expenses and essentials (Needs), 20% of your net income should go towards debt reduction and savings (Debt Reduction and Savings), and 30% of your net income should go towards discretionary spending (Wants).
What is the 60 20 20 rule? ›
If you have a large amount of debt that you need to pay off, you can modify your percentage-based budget and follow the 60/20/20 rule. Put 60% of your income towards your needs (including debts), 20% towards your wants, and 20% towards your savings.
Should rent be 30% of gross or net? ›
A popular standard for budgeting rent is to follow the 30% rule, where you spend a maximum of 30% of your monthly income before taxes (your gross income) on your rent. This has been a rule of thumb since 1981, when the government found that people who spent over 30% of their income on housing were "cost-burdened."
Can I spend 40% of my income on a mortgage? ›
The 28% / 36% rule is based on two calculations: a front-end and back-end ratio. As we've discussed, this rule states that no more than 28% of the borrower's gross monthly income should be spent on housing costs – but it also states that no more than 36% should be spent on total debt costs.
