Budgeting can help you stay on top of your personal finances; however, many Canadians find it to be a daunting task. A lot of people struggle to strike a balance between their spending and savings, and times of high inflation rate can only make matters worse.
One of the easiest ways to start budgeting is to follow the 50/30/20 rule (sometimes referred to as the 50/20/30 rule), a simple strategy that even beginners can follow. The rule, which is also known as the ‘balanced money formula’, was introduced in the 2005 book ‘All Your Worth: The Ultimate Lifetime Money Plan’, written by US Senator Elizabeth Warren and her daughter Amelia Warren Tyagi.
The 50/30/20 rule is very straightforward. All you need to do is divide your after-tax income into three spending categories – needs, wants and savings. The allocation is as follows:
Read below to know what is included in the three categories.
Needs include all the absolute necessary expenses that are essential for survival. These are unavoidable expenses which include rent or mortgage payments, groceries, utility bills, insurance, car loan, car insurance, other transportation costs, healthcare costs, childcare costs, property taxes, minimum debt payments and anything that can be called a must-have.
As per the rule, these expenses should be covered by 50% of your take-home pay. If your expenses exceed this number by a considerable margin, you could make some lifestyle changes to reduce your expenses. Some of the ways you could reduce your expenses are:
You should always look at these expenses as a whole and not individually. For example, you may decide to move to an area with a cheaper rent to save money; however, you may end up paying more for transportation because of a lack of public transport in that area.
This category includes the expenditures that are not essential, but are more of indulgences or luxuries that you choose to spend on, to make life enjoyable. This category could include dining out at restaurants, going to the movies, entertainment subscriptions, gym memberships, going for weekend getaways or vacations, buying designer accessories or expensive jewelry, and basically all the extras that you could live without if required to.
It is recommended that you spend at most 30% of your income on this category and you could even choose to spend less. If you are spending more than 30% of paycheck on your wants, it may be worthwhile to assess which expenditures can you curb. For example, if you dine out at least twice a week and realize you are overspending on your wants, you could start eating out only once a week instead. You don’t need to stop enjoying your life, you just need to make more conscious choices about spending.
The last category is savings which includes all your savings, investments and repayment of outstanding debts. Your savings and investments can be in an Registered Retirement Savings Plan (RRSP) or a Tax-Free Savings Account (TFSA); or even in a non-registered account. You could save in a High-Interest Savings Account; or make investments such as in stocks, bonds, Guaranteed Investment Certificates (GICs), Exchange-Traded Funds (ETFs) or Mutual Funds.
The category of savings can also include debt repayment. Minimum payments are considered as a part of the ‘needs’; however, the additional payments that you make which help in reducing debt and future interest are classified as savings. In fact, clearing any high-interest debt could be the first thing that you do with the 20% savings. If you do not have an emergency fund, the next thing to do could be to set up one. This will ensure that you have savings to fall back on in case of emergencies such as job loss, medical emergencies or any unforeseeable expenses.
Your savings should depend on your personal financial goals. Your goal could be to build an emergency fund, save for retirement, to save for your child’s education or even to save for the downpayment for a house. You could also have multiple savings and investments for separate goals. Savings can add up very quickly. If your after tax income is $4,000 every month, you could be saving as much as $800 every month going by the 20% rule, which translates to $9,600 in a year. Even though the rule suggests saving 20% of your paycheck, you should always save more if you are able to.
Let us assume an average individual living alone in Toronto. As per the Labor Survey of Canada, the average weekly wage of a 25-54 year old in Ontario for the month of October 2022 was $1,435.52. This will add up to an annual income of approximately $74,600. The after tax income of this individual would roughly be $55,953 which translates into $4,663 after-tax monthly income. Now, as per the 50 30 20 rule, the allocation of fund would be:
As per TRREB’s rental market statistics, the average rent for a 1-bedroom condo in Q3 of 2022 was $2,481. This alone is more than 50% of the individual’s take-home income. Let us assume that the individual needs to spend on the following as well,
Assuming that the individual pays the average rent, the needs alone add up to $3,571 or almost 77% of the take home pay, with only 23% left for wants and savings. In such a situation, if the individual wants to reduce the expenditure on needs in order to align with the 50-30-20 rule, they could take certain measures to downsize their lifestyle such as sell the car and start using public transport, move to a place with a cheaper rent or move in with roommates to share the rent.
The following steps can help you make a 50-30-20 budget for yourself.
The first and foremost step is to find out your after tax income. You could use our income tax calculator to help you do the same.
If you are an employee, your employer deducts taxes from your pay and the amount you receive in your account is the after-tax income. You could check your recent paychecks to find out how much you get paid every month. If your employer also deducts any insurance premiums from your pay, you could add them back up as you would later account for them in your needs.
If you are a freelancer, contractor or self-employed, your pay would be what you have earned in the month minus the amount you set aside for taxes, and your business expenses that are deductible. Take a look at your bank statements to calculate what you’ve earned.
The next step is to make a list of everything you have spent in the past month. From your rent and grocery bills to every uber ride and meal that you order. Pull up your recent bank statements and all the bills that you can find. Also make a note of any savings or investments you made in the last month.
Once you have everything in place, divide your expenses into needs, wants and savings as defined in the text above. Be sure to classify your needs and wants carefully, anything that you could live without should be categorized as a want and not a need.
Once you have all the expenses sorted into categories, you would get an idea of what percentage of your after-tax income are you spending on what category. Assess your expenditure against the 50-30-20 allocations to get an idea of where you need to make adjustments.
You may come to realize that you are spending too much on wants and saving too little. You could then evaluate what expenses can be cut down on and make adjustments to align your expenses with the 50-30-20 rule. You should finally have a budget that can act as a guideline for your expenditure.
The 50/30/20 rule is a simple and straightforward budgeting method that can be easily adopted even by beginners. Even though the rule requires you to dedicate 50% to needs, 30% to wants and 20% to savings, you could always adjust the numbers as per your individual circumstances. Following this money management technique can help you get closer to your savings goal and help reduce your debt. You should reassess your budget every once in a while and make adjustments as your circumstances evolve.