It’s the summer of 2015 and my mom has let me know I won’t be using her Pontiac G6 much longer. That G6 breaks down and I have to pay almost $900 to get it fixed while my student loan money is just about to run out. I don’t know when my first paycheck is going to come; I reluctantly tell a close friend I cannot attend her bachelorette party because I literally cannot afford it. I am running out of money and my mom is telling me I have to drop several thousands to buy a car in the immediate near future.
At that point I had no idea how much I needed as a down payment to buy a car and I felt like any monthly payment was too high to be able to save any money. I was working, technically, because I had been to several planning meetings at the school that hired me earlier that year. The school paid for me to fly to a conference in Chicago but not all of the expenses were covered. Things were tight for a few months. I hated the way I felt. I mean, I absolutely despised that feeling in the pit of my stomach: worrying what would happen to my accounts and credit if something else went wrong. How would I afford it? I would end up having to pay interest on my credit card, which was one of the worst financial crises I could imagine at that point in my life. I was not going to live with that pit in my stomach. I took to Google and found several budgeting recommendations about that car payment but I found an even better gem that I use to this day. I teach it to my students as one of the first concepts about money.
the 50/20/30 rule
The budget rule known as the 50/20/30 rule is a simple way to sort your income in to different piles of money. If you are able to break down your take home pay with this framework before making any major decisions like buying a car or signing a lease on an apartment, you will be making a much more informed decision. I love checking my spending and saving against this rule. I consider myself successful if I end up matching the rule for a month.
Part 1: Fixed Costs. 50% of your income should be allotted toward fixed expenses. Fixed expenses are anything fixed into your budget every month. I consider these fixed line items. This would be items like rent, electric bill, phone bill, etc. It should also include things like Netflix subscription or gym membership, because you always pay them every month. The category is not essential items, so feel free to include anything you regularly pay for and keep the category to 50% or less of your monthly check. Some people I know argue quite strongly that Netflix is not a fixed expense, and if that works for you, then great! I’d really strongly advise, though, not letting those other bills you do consider fixed go up to 50% and then add in a bunch of “fun” expenses (that you totally pay every month) take up space in the other 2 parts of your budget. The fixed spending is where that car payment I was about to add in the budget goes.
Understanding essentially that “bills” should total no more than 50% of my budget really helped me get a handle on my income before I started receiving it. I asked a friend who was working at the same school how much she was getting paid (which isn’t that taboo for young teachers since we all get paid the same and it is public record). I estimated taxes and retirement and was able to start calculating my future budget.
Growing up, my dad always told me that rent or mortgage should be one week’s paycheck, or 25% of a month’s income. I don’t know why he was talking about this so much but it was probably whenever the mortgage bill came due that he was reminded to impart some financial wisdom on me. It stuck. I found an apartment that is exactly 25% of my take home pay, $600. Through research and doing the math myself, I figured that I could handle a car payment of about half that. So I do currently have a car payment of $300 a month. Several sources aimed at making a car payment be about 5-15% of your monthly income. At this point in my life, though, I really strongly recommend aiming for the lower end of the spectrum and spending as little as possible on the fastest depreciating asset you can own.
Part 2: Financial Goals. 20% of your income should go toward financial goals, such as paying down debt and saving for the future (house down payment, retirement, or emergency fund). So right off the bat, if you have an auto loan, you can argue that the car payment goes here. I hate that idea. 20% isn’t very much of your income and you want to include a hefty car payment as more than half that category? No thank you! For my first year and a half of teaching, I used this category completely as saving. And I actually made it be the larger category, occupying 30% of my budget.
What many of us millennials will need to use this category for is student loans. When I first started out, I included my student loan as a fixed cost (I’ll explain that a little bit below and more in a later post about taxes). Now, I include my student loan repayment as a financial goal which is a little more than 6% of my total and use the rest for a traditional savings account.
Credit card repayment: pay it off as quickly as possible and never allow that to become a line item in your budget again. You’re probably paying a terrible 20% interest on that money and drastically reducing your ability to save until it’s paid off. Do not go in to debt just to shop! I never carry a balance on my card and use it primarily for security reasons like spending on vacation or during the holiday season.
Part 3: Flexible spending. 30% of your budget can go toward flexible spending, so things that go up and down depending on the month. Groceries and gas for your car are listed here because they can change so drastically depending on if you’re taking trips home or traveling. Groceries can be cut down or really be a luxury. Again, some people will argue that these items belong in “fixed spending” because you always buy them. If that works for you, then great! The 50/20/30 rule is just about setting up different piles of money and setting limits for yourself. This prevents you from wondering where your money goes, and G-d forbid, you running up a credit card bill beyond your ability to repay in a single month.
Flexible spending also is for allowing you to have some fun! Life isn’t just about paying bills and saving money. You need to enjoy yourself. You just need to also live within your means. So a Cavs game can be paid for with this 30% chunk. Date nights, movies, toys on Amazon, or whatever your hobbies are. Spend away… but no more than 30% of your income less groceries and gas.
Tying all 3 parts together: I had a difficult time finding in my original research on this budgeting rule whether it should be for take home pay or gross pay. The main reason I developed that question was different reading that talked specifically about pre-tax retirement savings. Many websites recommend 5% and some 10% for contributions to a 401(k) but that comes from your gross pay, not your net pay. For me, I just make this budgeting rule all about what actually goes into my bank account. So I ignore the 14% that goes to STRS and the other 5% that goes to my 403(b) and pretend that money never existed.
Feel free to adjust the percentages in a way that work for you. The best way to achieve your goals, of course, would be to increase the financial goals category to allow as much saving or investing as possible. Reduce expensive bills like living alone if you can have a roommate.
in my first year of teaching, I had a take home pay of $2496 and I had this framework for budgeting:
|50/20/30 Rule||allowed||my spending|
|50% toward fixed costs||1248||1255.66|
|20% toward financial goals||499.2||154|
|30% flexible spending||748.8||210|
Notice here I was spending a little more than 50% for my fixed costs. The main reason was my high car insurance rate. I really struggled for a while with car insurance because of my bad record of speeding tickets. I was paying $138 at one point, then brought it down to $126, which is reflected in the totals here. Now I pay $101.33 after switching providers.
What’s not included in that table is the amount I saved. During my first year of teaching, I saved around $700 a month, every month. One month I saved only $390 but that was offset by a previous month of saving $1051. I was obsessed with saving. I’d been in school or putzing around for far too long and I wanted to build up my savings. The first thing I said after I was hired at my job was “I can’t wait to buy a house.” In my mind, I was planning a traditional, old school down payment of 20%. I actually switched the percentages for financial goals and flexible spending. I aimed to save around 30% of my income and spend only 20% of it on gas, groceries, and fun. This worked for a while, until I made some changes, both willingly and unwillingly.
I have since gotten a raise, started contributing to my 403(b) retirement supplement, turned 26 and had to get my own insurance, and have had a tax withholding change. During my first year and a half, the only retirement I contributed to was the mandated STRS contribution of 13% then 14% of my income. I opened a 403(b) in April 2017 and I contribute $100 per check to the account. When I was still in my parents’ insurance, I paid them my share each month of just $20.20. Now I pay $90 per month for 10 months of the year. It’s certainly an excellent premium rate compared to other rates, but for me it was a nearly 350% increase in cost.
My total take home pay now is $2435, meaning my fixed costs should be around $1217, my financial goals should be around $487, and my flexible spending should be around $730. I keep my goals at the original 20% recommendation for now because my fixed costs do go a bit over that 50% mark, since it is actually lower than my first two years working. The biggest difference between my budget now and the budget above, is that I am contributing more to my retirement fund with pre-tax dollars. I now contribute 19% of my gross income in total to retirement accounts.
I know that I won’t hit this exact distribution every month but I try to stay close, so that I do not waste money. It has served as a solid framework for keeping me focused. It disallows frivolous spending but allows for the enjoyment of life. If you’re trying to get your financial house in order, I recommend starting with the 50/20/30 rule. Cut down your expenses as much as possible to fit within this, especially if it means cutting out cable or reducing spending on a coffee habit. If not 50/20/30, you need some guide to make your money work for you. Do you have a budgeting framework you use?