Budgeting

Defining Terms

Income: The amount of money you earn after taxes, from all revenue sources, each month.

Expenses: The cumulative cost of all the things you need to pay for in a given month. This includes monthly bills such as your water bill, telephone bill, rent or mortgage, food, and insurance. These are necessities needed to live at your current standard of living.

Savings: The money you put away for future use in an interest earning account such as a savings account. Savings can be for short-term goals such as gifts or vacations, as well as long-term goals like grad school or retirement.

Usable Funds: The money you have left over to spend on the things you want. This is the money you can afford to spend before you go into debt.

Rules and Examples

Now that we’ve defined each of these terms, let’s see how they actually play out in real life. We are going to use the 50-20-30 rule to determine how much money we should be allotting to each of these categories. This rule states that we should spend 50% of our income on expenses, 20% towards savings and the remaining 30% as usable funds.

Imagine that a recent graduate has started his accepted his first job after college and wants to get his career off on the right foot. He has an annual salary of $42,000 per year, which equates to $3,500 per month. His tax rate is approximately 25%, so he nets $2,625 per month. If we apply the 50-20-30 rule, our graduate should be saving $525, using $1,312.50 on expenses and $787.50 on usable funds. If there are months where expenses exceed $1312.50, you should draw from your usable funds as a first line of defense. You should only dip into savings if it’s absolutely necessary. If there are multiple months in a row that you have to draw from savings, this is a good indication that you may need to change your lifestyle a bit. Also it is recommended by many financial advisors to keep enough money saved to pay your expenses for 6 months.