How to Spend Your Paycheck Correctly

How to Spend Your Paycheck Correctly?

Updated on

How to Spend Your Paycheck Correctly

It always feels good when it’s payday, and you earn your paycheck, but you must spend it wisely. Most people would spend all of their money on discretionary goods and services, items that are nonessential, such as expensive clothing brands, entertainment, and alcohol.

Doing this will set you up living paycheck-to-paycheck. Instead of setting aside a percentage of their paycheck into savings and investing, they will be worse off in the future.

You need to be responsible for your finances and learn to prepare yourself to have money set aside for the future.

We have the urge to spend it all on fun and exciting things at the moment after putting many hours of work, but this is irresponsible and how most people are struggling with their finances.

There is no single way to spend your money correctly, as everyone has different levels of income and financial responsibilities. However, financial professionals have tested and reviewed budgeting tips on how to spend your paycheck.

Review these practices and see what you feel is comfortable with your situation. You can always adjust how you spend your paycheck but always set aside money for investing and have enough funds for emergency savings.

You’re allowed to spend on discretionary things and have fun but don’t overdo it.

Disclaimer: This article contains affiliate links that I receive a small commission for at no cost to you. You can read my full affiliate disclosure in my privacy policy.

50/30/20 Budget

A popular way to allocate your paycheck is the 50/30/20 rule. Senator Elizabeth Warren created a budgeting plan from her book All your worth: The Ultimate Lifetime Money Plan.

It’s a simple budget plan on how to use your after-tax income effectively between how to spend money on your needs, wants, and savings/ investing.

50% – Essentials/ Needs/ Living Expenses

In this category are goods and services that are absolutely required for you to pay as a need for survival.

Food, water, shelter, and clothing are essential for survival. About 50% of your paycheck should be paying for these essentials.

Examples of Essential Expenses:

  • Groceries
  • Rent/ Mortgage
  • Transportation Costs
  • Health Insurance
  • Utilities (Phone/ Electricity/ Water/ Garbage)

If you’re spending more than 50% of your paycheck on essential expenses, then you should reconsider reducing your lifestyle spending.

Examples are spending less when grocery shopping, find cheaper options for rent or refinance for lower mortgage rates, take public transportation instead of driving, and negotiate with your insurance.

30% – Wants/ Non-Essentials

The next category is the goods and services that you are free to spend; however, you like. You can buy luxury items and services that aren’t more than 30% of your paycheck.

Examples of Non-Essential Expenses:

  • Dining Out
  • Buy Luxury Clothing Brand
  • Vacation
  • Buying New Luxury Cars
  • Entertainment Events
  • Alcohol

You may need to reduce to more than 30% of your spending on non-essentials if you have debt or other financial responsibilities.

Although, you can set a certain percentage of your paycheck from wants into savings/investing to speed up making more money after paying living expenses.

20% – Savings/ Investing

The last category is setting aside 20% of your paycheck into savings and investing. Start with building up an emergency fund with at least three months or more of total living expenses in case you lose your job or an unforeseen financial difficulty comes to you.

Then focus on maximizing your retirement accounts to reduce your tax payments and be better off in the future when you’re old.

Savings/ Investments Examples:

  • High-Yield Savings Account
  • 401K Plan
  • Individual Retirement Plan (IRA)/ Roth IRA
  • Index Funds
  • Exchange Traded Funds (ETF)
  • Mutual Funds

Review what you are investing in before making purchases. Some investments are of higher risk of you losing your investment while some offer low risk but less investment return.

The 50/30/20 plan is not something you should strictly follow.

Use it as a guide based on your financial situation as everyone is in a different financial position where some people prefer to save or invest more than spending on non-essentials, or are unable to due to paying off debt first.

Adjust if you need to but keep it consistent.

Personal Circumstances

Everyone are in different financial circumstances and will need to adjust how to spend their paycheck.

For example, if you’re living in Los Angeles, then you’ll more than likely be spending a lot on housing, depending on your level of income.

Most people don’t look at their spending or how much is in their bank account, and it creates financial difficulty in the future.

How to Calculate Your Financials:

  1. Calculate how much money you make monthly
  2. Add up all Essential Expenses (Housing, Groceries, Insurance, Utilities, etc)
  3. Add up all debt you’re required to pay off monthly
  4. Essential Expenses + Debt = Monthly Essentials
  5. Monthly Income – Monthly Essentials = Disposable Income

Your disposable income is what you are allowed to spend on non-essentials and putting into savings and investing. Start planning how much you’re willing to save and invest first before setting money aside for non-essentials.

First, set aside enough money to last 3 – 6 months in savings as an emergency fund, then choose a fixed amount of funds or a fixed percentage of how much monthly disposable income you want to invest.

Keep non-essentials to a small amount or small percentage, and you’ll thank yourself in the future. Calculating your financials should take only 1 hour of your day at most.

By having a budgeting plan in place and carrying out on it, you’ll be financially wealthy in the future.

If you make purchases using a card, then go to your online bank account and make a note of each purchase as either essential expenses or non-essentials or if the money was put into a savings account or purchase investments.

Then follow the steps for calculating your financials.

Mint

Besides tracking from your bank account by hand, you can download the app from Mint and link your bank accounts to track the income you received and how much you spent.

The app categorizes your spending into different areas from groceries, entertainment, insurance, and many more.

At the end of each month, the app will calculate how much income you earn and deduct your spending to give you a report on your disposable income.

The app can miscategorize purchases if it’s an unusual item or service. You can quickly review and rename miscategorize purchases for an accurate representation of your monthly report.

Common Best Practices

Here is a list of common financial tips for how much percentage of your paycheck should be spending:

  • Mortgage/ Rent: 30 – 35%
  • Groceries/Food: 10 – 15%
  • Transportation: 10 – 15%
  • Savings/ Investing: 10 – 20%
  • Personal Spending: 5 – 10%

Feel free to adjust your paycheck spending that best fits your situation. Be aware of how much you spend on non-essentials and keep it at a minimum.

Following a budget plan and continue to carry it out avoids living paycheck-to-paycheck.

You’ll set yourself up for success by having enough financials set up in your savings account, and continue buying investments.

Knowing by offsetting money you want to spend now, you’ll build more wealth for the future

The author of WealthyPayoff has contributed 12 posts