Do you know the 60/20/20 rule for budgeting? How much you should have in your emergency fund? Or why you should keep your credit card utilization at 30% of your limit? Many Americans are unfamiliar with these financial basics. If you’re new to these rules or just want a quick refresher, read on. Below, we’ll give you the tools to build your financial knowledge, from short-term savings to retirement planning.
Budgeting helps you track your income and expenses and earmark funds for loan repayment, savings, and other financial goals. A popular budgeting rule is the 60/20/20 rule. Here’s how it works:
The 60/20/20 rule is a great starting point, but you may need to tweak the approach to fit your individual circumstances and lifestyle.
Because life is unpredictable, it’s a smart idea to have some money tucked away for emergencies like an unexpected car repair, medical bill, or sudden job loss. Experts recommend that you have enough to cover 3 to 6 months of expenses. Start with $500 and build from there. Consider a high-yield savings account or money market account for your emergency fund.
Credit cards are convenient, but you need to use them responsibly. Keep your credit card balances below 30% of your credit limit. Lenders and credit bureaus closely monitor your credit utilization ratio, which is the percentage of available credit you’re using. Exceeding 30% can signal that you’re relying heavily on credit and may struggle to repay your debts. This can negatively impact your credit score.
A good credit score opens doors to lower interest rates on loans, better credit card offers, and even favorable terms on insurance premiums. A high credit score is essential for achieving major milestones like buying a home, purchasing a car, and obtaining student loans. By keeping your credit card utilization below 30%, you’re demonstrating responsible financial behavior and building a solid foundation for your financial future.
Strive to save 15% of your income for retirement. The earlier you start, the more time your investments have to grow. Aim to replace about 70% of your pre-retirement income, and when you begin withdrawing, limit yourself to about 4% per year.
If your employer offers a 401(k) match, contribute enough to get the full match. It’s essentially free money and can help boost your retirement savings.
Limit housing expenses (mortgage/rent, taxes, insurance) to no more than 30% of your gross income (your total earnings before taxes and other deductions). This prevents housing costs from overwhelming your budget and frees up money for other financial goals.
Keep your debt-to-income (DTI) ratio below 36%, including your mortgage. This is calculated by dividing your total monthly debt payments by your gross monthly income and multiplying by 100. A lower DTI ratio indicates to lenders that you have a manageable debt load and are more likely to repay borrowed funds responsibly. This can lead to easier loan approvals and more favorable interest rates.
Before making a major discretionary purchase, consider how you'll feel about it in 10 days, 10 weeks, and 10 years. This is a good way to avoid a purchase you might later regret.
When selecting a vehicle, consider not just the sticker price but also the ongoing costs of ownership. A general rule of thumb is to keep your total monthly car expenses at or under 10% of your take-home pay. This includes the loan or lease payment, insurance premiums, gas costs, and maintenance and repairs. Be sure to factor in these expenses when determining how much car you can truly afford to avoid overextending your budget.
Some experts recommend starting with the lowest balance first and paying it off, but you’ll save the most and get your debt paid off more quickly if you tackle high-interest debt first. If you have credit cards that are maxed out, pay them off first and then pay off debt from the highest to the lowest interest rate.
As soon as you get paid, put some money into a savings account. This helps you save rather than spend your money. Better still, automate your savings so that a certain percentage of your paycheck goes right into savings. Consider a high-yield savings account or money market account to earn a higher rate while keeping your funds accessible. Automating your savings can help you to better manage your budget and avoid a paycheck-to-paycheck cycle.
Finally, review and adjust your budget, investments, and financial goals at least once a year. Regular checkups can help you spot and correct any financial issues early, take advantage of new opportunities, and adapt to changes in your income or expenses.