Is There a Spending Formula?

savings
Is there a spending formula?

Yes! If you are trying to figure out how much of your budget to allocate to different expenses, one of the easiest formulas I’ve come across is the 50/30/20 formula. It is fairly simplistic, but it also allows you some flexibility and a great starting point if you are trying to get started with budgeting your personal finances.

Do you need a budget? There are definitely some people that do not need a budget to keep their spending in check. These tend to be the people that are naturally frugal, understand their spending inside and out, or just don’t care (maybe they have too much money!?!?). Personally, I like having a budget to keep myself accountable to my spending and to measure myself monthly against how much I think I should spend. Obviously there are always going to be exceptions and emergencies, but for general spending, a budget is a great to have to compare to.

Step 1. Calculate your after-tax income. Although you may get paid $20 an hour or maybe $50,000 a year, you don’t actually take home that much money. You have federal taxes, social security, medicare, state taxes, and probably also health care premiums. Take a look at your most recent paychecks and determine how much actually goes in to your pocket.

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Allocate your after-tax income!

Step 2. 50% Needs. The biggest portion of the allocation is everything you need to pay for to live adequately. This includes housing (mortgage or rent), utilities, food, debt payments, and insurance. Additionally, it could also include your transportation costs if this is something you need based on where you are living or to get to your job.

Step 3. 30% Wants. The next category includes all the extra stuff. These expenses are things you could do without if you absolutely had to. They are things you want or “nice-to-haves” and may crimp your lifestyle, but won’t cause you distress if you can’t pay for them. Wants include things like eating out, memberships (gym, golf, clubs, etc.), vacations, and entertainment.

Save at least 20%

Step 4. 20% to Savings. Funding your savings or paying extra on your debts are important aspects of keeping you financially healthy. Being about to contribute at least 20% of your after-tax take home pay to savings and debts will help fuel your retirement, financial independence, and all-round finances.

The 50/30/20 Spending Formula is an easy way to start budgeting. I would recommend tracking your expenses first to understand how much you are currently spending on a monthly/annual basis. And if you are on your way to achieving financial independence, reducing your expenses (needs and wants) and increasing your savings will get you there much faster. It’s often more difficult to reduce your needs unless you move to a smaller home or cut your grocery spending, but you have more control over reducing your wants. In my case, I was able to cut out most of the things in my wants category (clothes, shoes, expensive haircuts, eating out) over the short-term to achieve financial independence quickly. It may be a burden at first look, but it can bring you happiness and freedom in the long-term.

Do you use a Spending Formula for budgeting?

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