50/15/5: a saving and spending rule of thumb

Budget. Does anyone like that word? How about this instead: the 50/15/5 rule? It’s our simple rule of thumb for saving and spending. Not more than 50% of your take-home pay should go to essential expenses, 15% of your pretax income to retirement savings, and 5% of your take-home pay to short-term savings. (Your situation may be different, but you can use our rule of thumb as a starting point.)

Why 50/15/5? We analyzed hundreds of scenarios in order to create a saving and spending guideline that can help you save enough to retire. Our research found that by sticking to this guideline, you’ll have a good chance of maintaining financial stability now and your lifestyle in retirement. To see where you stand on our 50/15/5 rule, use our Savings and spending check-up.

Step 1. Essential expenses: 50%

Some expenses simply aren’t optional—you need to eat, and you need a place to live. Aim to have no more than 50% of your take-home pay go toward your “must-have” expenses, such as:

  • Housing—mortgage, rent, property tax, utilities (like electricity), homeowner’s/renter’s insurance, and condo/home association fees

  • Food—groceries only; do not include takeout or restaurant meals, unless you really consider them essential, i.e., you never cook and always eat out

  • Health care—health insurance premiums (unless they are made via payroll deduction) and out-of-pocket expenses (e.g., prescriptions, co-payments)

  • Transportation—car loan/lease, gas, car insurance, parking, tolls, maintenance, and commuter fares

  • Child care—day care, tuition, and fees

  • Debt payments and other obligations—credit card payments, student loan payments, child support, alimony, and life insurance

Keeping it below 50%: Just because some expenses are “essential” doesn’t mean they’re not flexible. Small changes can add up, such as turning down your thermostat a few degrees in the winter (and up in the summer), buying—and stocking up on—groceries when they are on sale, and bringing your lunch to work. Also consider driving a more affordable car, carpooling, or taking public transportation. Consider a high-deductible health plan (HDHP), with a health savings account (HSA) to reduce your health care costs and taxable income. If you need to significantly reduce your living expenses, consider a less expensive home or apartment. There are many other ways that you can save. Take a look at which essential expenses are most important, and which ones you may be able to cut back on.

Step 2. Retirement savings: 15%

It’s important to save for your future, no matter how old you are. Why? Pension plans are rare. Social Security probably won’t provide all the money you’ll need to live the life you want in retirement. That means you’ll likely have to fund much of your retirement on your own. You can do it. It just means starting early, saving consistently, and invest wisely. It’s important to take full advantage of a tax-advantaged retirement savings plan, such as a 401(k), 403(b), or IRA. In order to give yourself a good chance of meeting your income needs in retirement, we suggest saving 15% of your pretax household income for retirement. That includes your contributions and any matching or profit sharing contributions from your employer.

How to get to 15%. If contributing that amount right now is not possible, see if your employer has a program that automatically increases your contribution annually until you meet your goal. Another strategy is to contribute at least enough to meet your employer match, and then if you get a pay raise or bonus, take all or part of it and allocate it to savings.

Step 3. Short-term savings: 5%

Everyone needs an emergency fund. An emergency, like an illness or job loss, is bad enough, but not being prepared financially can only make things worse. A good rule of thumb is to have three to six months of essential expenses readily available. Think of your emergency fund contributions as a regular bill every month, until you have built up enough.

Once you have a sufficient emergency fund, turn to saving for those short-term expenses that pop up unexpectedly. Who hasn’t been invited to a wedding—or several? Cracked the screen on a smartphone? Gotten a flat tire? Setting aside 5% of your monthly pay can also help with these “one-off” expenses. Don’t be tempted to pay for one by adding to an existing credit card balance. Over time, these balances can be hard to pay off. However, if you pay your entire credit card balance every month, and you receive some sort of incentive for purchases, using a credit card for one-off expenses may make sense.

How to get to 5%: Make it automatic. Have this money automatically taken out of your paycheck and deposited in a separate account just for short-term savings.

What next?

Our guidelines are intended to serve as a starting point. It is important to evaluate your situation and adjust these guidelines as necessary. That said, if you are close to the 50/15/5 target spending and saving allocations, pat yourself on the back and keep doing what you are doing. So long as you stay within the guidelines, the remainder is yours to save or spend as you see fit. Some ideas: First, if you have high-interest debt, you could pay it down. Then if you have other goals, like paying for a child’s college or wedding, you could use it to save for them. And, finally, if you want to retire early, or if you haven’t been saving diligently, you may want to put it toward retirement savings.

The good news is that you don’t have to micromanage every penny. Analyzing your current spending and saving based on our three categories can give you control—and confidence. Undoubtedly, your financial situation will change over time. A new job, marriage, children, and other life events may change your cash flow. Plan to revisit your spending and saving analysis regularly to see where you stand.

Source: 50/15/5: a saving and spending rule of thumb

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