All your expenses fall into two categories – needs and wants. Correct needs assessment and rational allocation of funds will help to accumulate equity capital more efficiently.
The 50/30/20 rule
There is no perfect method of budgeting, but the 50/30/20 rule can be a solid starting point. The bottom line is this: the net income that you have left after taxes must be divided by the estimated expenses.
For example, your annual salary is $ 60,000. Half of this amount ($ 30,000) you spend on basic needs – housing, utilities, loans, education, food, clothing, and so on. The final list depends on the individual needs of each person. The next 30% ($ 18,000) is spent on entertainment – vacation trips, fishing gear, musical equipment, and more. And the remaining 20% ($ 12,000) you save as savings or invest in assets that are on the stock market.
This percentage of expenses is rather arbitrary: what suits one person is unacceptable for another. The amount of earnings can change from year to year, as well as your needs and desires. V
50/30/20 is the best option for middle-income citizens. If it is not high, such a scheme for distributing funds is not suitable: more than 50% of the salary is spent on basic needs. For those who earn a lot, the rule is also not suitable, because they do not have to spend half on basic needs.
The 50/15/5 rule
With this option, half of the earnings is spent on basic needs, paying off loans and other debt obligations. 15% can be used for pension contributions, and 5% can be put into the reserve fund. As a result, you will have 30% of unused funds. How to spend it (on vacation or investment), you decide on your own. The rule is not very different from the 50/30/20 scheme. Here 20% is divided into two parts and redirected to the implementation of long-term goals – pension provision and the reserve fund
The main principle of money management is this: the total amount of expenses should not exceed the total amount of income. This is the only way to preserve and increase your own capital.
When we talk about income, we mean two types of income:
- Gross income is your earnings before retirement benefits and taxes. This can include the salary at the main job, income from savings, investment accounts, and so on.
- Net income is the amount that remains with you after all taxes have been paid. It is the net profit that must be taken as a basis when distributing the budget.
All expenses are divided into two groups:
- Fixed (permanent) – utilities, loans and other monthly payments.
- Periodic (one-time) – things that you want to buy, but you can do without them, saving money or spending for other purposes.
For most citizens, the main fixed costs are related to housing. It also includes the purchase of groceries, tuition fees, debt payments, car loans, and so on. Recurring expenses include the purchase of new clothes, household appliances and other expenses.
Your spending list may differ. Insert your options and calculate how much your life will cost using the following formula: cost of living = total fixed expenses + total recurring expenses.
To calculate the amount of annual expenses, multiply the amount of monthly expenses by 12. Then divide all expenses by the amount of net annual income, and you will understand how much money will be left for the implementation of other goals.
Perform such calculations regularly, for example, once a month. Recall what you bought during the “reporting period” and calculate how much money you spent. If the total is less than the net income, you have saved yourself, and you can postpone the remainder or spend on other purposes.
Regular calculation will help to identify unnecessary or unnecessary expenses that you need to get rid of (for example, a subscription to an online cinema, if you turn it on once or twice a month). The amount of expenses every month will not be the same, since you may have one-time expensive purchases (for example, a smartphone, a coffee machine) or unplanned expenses (repairing a laptop, car). When planning a budget for the year, all expenses should also be divided into twelve months, and unplanned expenses should be carried out from the reserve fund.
Accumulation of the reserve fund
Reserve fund – deferred money that cannot be spent on current or recurring expenses. They are needed in case of force majeure – illness, traffic accident, job loss, and so on. Setting up an emergency fund is difficult if you live paycheck to paycheck, but you still need to try to save money.
Some financial advisors advise having an amount in the reserve fund that will fully cover living expenses within three months. Others recommend keeping funds for a rainy day that will last six months or more. How much is enough for you – decide for yourself.
Investing in the future
If you are considering investing, chances are you already have goals set. Perhaps this is the purchase of a house, a car, regular transfers to a pension fund, and so on. Determining the exact percentage of income required for investing is quite difficult, since each person has their own goals. For example, if you are looking for a good pension when you reach a certain age, you need to make regular contributions to the pension fund.
What to do?
Budget planning is keeping track of your income and expenses with adjustments to achieve your goals. Planning is carried out in several steps:
- Calculation of the amount of net income.
- Drawing up a list of expenses to pay for basic needs and desires.
- Deduction of expenses from net income.
If the final balance turns out to be positive, then you are not spending all your earnings and are gradually increasing your capital. A negative figure indicates an accumulation of debt.
It is important to learn how to keep track of your own funds. Planning helps to correctly distribute the money earned to current expenses, savings and investments.