Today, the economies in many states are in some sort of re-opening stage. But that doesn’t necessarily mean you should quickly return to your “normal” financial lifestyle. For many people, the spending and saving habits they followed during the pandemic could actually be how they should have been handling their finances all along.
They say that “necessity is the mother of invention.” When it comes to personal finances, it’s also the “mother of frugality.” But cutting back on unnecessary expenses so that we spend less than we earn can help us get ahead in our financial lives. It’s a great practice for people to continue doing even after the end of the pandemic.
So before you go back to eating out every other night or re-subscribe to all those streaming services, let’s take a look at how much your lifestyle should cost all year-round.
Related: These are the best apps for building savings habits
How Much Should Your Lifestyle Cost?
One of the simplest and most popular budgeting models is the 50/30/20 budget. With this budget, the idea is that you should spend 50% of your after-tax income on needs, 30% on wants, and 20% on savings and debt repayment.
What makes this budget so nice is you only have three main budget categories to track, instead of a separate budget for every single type of expense. If you’ve cut back on discretionary spending during the COVID-19 crisis, there’s a chance that you’ve been following the 50/30/20 budget without even knowing it.
Let’s take a closer look at how the 50/30/20 budget is meant to work to see how your current spending habits compare.
How Much You Should Spend – Needs
The 50/30/20 rule mandates that no more than 50% of your monthly after-tax income should be spent on your “needs.” It’s very difficult to reach our savings and investing goals when more than 50% of our monthly incomes are immediately claimed by our required expenses. Here are the types of expenses that would be considered needs:
- Housing and utilities
- Transportation
- Groceries
- Health insurance
Let’s say that you have $4,000 of after-tax income. In that case, your goal would be to spend no more than $2,000 per month on the expenses listed above.
For most of us, cutting back on how much we spend on our needs is difficult, due to the fact that our mortgage/rent and car payments are fixed expenses. It can be difficult to lower your health insurance costs as well.
However, groceries is one area that many of us may be able to reduce cost. Meal planning, taking advantage of coupons, or shopping at big box stores and warehouse clubs are a few ways that you may be able to cut your grocery expenses by 25% or more.
Also, it should be pointed out that if your car and house payments are taking up a large percentage of your income, you may need to consider downsizing. Aiming to keep your debt-to-income (DTI) ratio below 35% is a good start.
How Much You Should Spend – Wants
Ok, so this is the category that most of us have probably been cutting back on during the pandemic. “Wants” should only account for 30% of our monthly expenses. Wants would include:
According to the 50/30/20 budget, if you have $4,000 of after-tax monthly income, you should restrict your spending on these types of expenses to $1,200 per month.
Perhaps for the first time in a long time you’ve gotten your “wants” expenses down to this level by eating out less often, canceling subscriptions, or taking other cost-cutting measures. If you add a few of those expenses back (now that the economy is opening back up) and still keep your “wants” expenses below 30% of your after-tax income, that’s perfectly fine. Otherwise, you may want to permanently keep some of those discretionary expenses out of your life.
In our family, we use our budgeting tool to create a “roll-over” budget for our “wants” expenses. So if we only spend $800 of our $1,200 in Month #1, we roll over the leftover $400 to give us a total “wants” budget of $1,600 in Month #2.
We like using roll-over budgets for “wants” items because we’ve noticed that certain expenses don’t necessarily happen every month. But when they do happen, they come in big chunks! For example, we may spend nothing on travel in January-June before spending $2,000 when we take our summer vacation in July.
Roll-over budgets are also commonly referred to as “sinking funds.” Sinking funds are a great way to save all throughout the year for non-monthly expenses. If you’re looking for a budget tool that can help you lay out your own 50/30/20 budget and sinking funds, Empower, and Personal Capital are a few of our favorites.
How Much You Should Spend – Savings and Debt Repayment
If you’ve reduced your discretionary spending during the pandemic and your “needs” expenses have stayed fairly the same (or even gone down a bit), then you may have suddenly noticed that you have 10% to 20% of your after-tax income left over.
And that’s exactly how your budget should work. With the 50/30/20 budget, 20% of your after-tax income should go to debt repayment, saving, and investing. On a $4,000 income, that would be $800 per month.
If you have credit card debt or other high-interest debt, you’ll want to pay that off as quickly as possible. After you’ve paid off your high-interest debts, you can zero in on your short-term savings goals, like building up your emergency fund. And once your emergency fund is in place, you can start working in earnest on investing for retirement.
To make sure that you prioritize your saving and investing goals each month, you may want to use an automatic savings app like Acorns, Stash, or Empower. And you may also want to use a tool like Personal Capital to track your financial progress and analyze your investing portfolio.
Related: How to Evaluate an Investment Portfolio
Customizing Your Budget to Your Personal Situation and Goals
The 50/30/20 budget is not a hard-fast rule. It can be tweaked for a variety of reasons. For example, if you live in an area with a high cost of living, you may need to use a 60/20/20 budget:
- Needs: 60%
- Wants: 20%
- Savings and debt repayment: 20%
Or if you’re part of the FIRE community and are currently pursuing early retirement, you may choose to follow a 30/20/50 budget:
- Needs: 30%
- Wants: 20%
- Savings and debt repayment: 50%
Budgeting guidelines are just that–guidelines. But the most important thing is that you budget and spend your money with intentionality so that you can reach your financial goals faster.
Related: Best Online Budget Tools
Bottom Line
The coronavirus pandemic has made a lot of us more intentional with our spending than we were before the crisis began. But now that you’ve discovered these new financial muscles, keep using them. Budgeting and living within your means are two financial habits that you can continue to benefit from long after the pandemic is gone.
