How can I start budgeting? Learn how to spend, save, and invest

When’s the last time you ate a marshmallow? Were you sitting around a campfire, maybe roasting smores? Did you eat one marshmallow or two, or did you leave the bag half-empty?

Marshmallows are a yummy treat — It also turns out they can reveal a person’s ability to delay gratification. In a famous 1970s experiment, Stanford psychologist Walter Mischel studied whether children had the willpower to not eat a marshmallow placed in front of them. If the children resisted the temptation for 15 minutes, they were rewarded with a second marshmallow. The kids who caved only got one. (You might’ve stumbled upon YouTube videos of these adorable tots, struggling to hold themselves back.) While it’s tempting to gobble up your marshmallows immediately (aka live for the moment), a long-term approach can prove more rewarding, especially when it comes to money. Gauging your needs and your wants can help you build a marshmallow-filled life in the future.

Here are a few ways to think about spending, saving, and investing using your after-tax income.

TL;DR: Spend 50% on needs, 30% on wants, and put 20% toward savings.

When it comes to budgeting, no rule is perfect, but the 50/30/20 rule is a pretty solid starting point. The basic idea is this: Take your net income (i.e., what you have left after taxes) and divide your spending into different buckets.

Let’s imagine you earn $50,000 each year, after taxes. Based on the 50/30/20 rule, you’d put 50%, or $25,000, toward your necessities — That means housing, utilities, food, clothes, maybe car or student loan payments, and insurance. It sort of depends what you consider a “necessity” (e.g., keeping a car in the city versus taking public transit).

Here’s how you calculate that: Amount to spend on necessities = After-tax income x 0.50

The next 30% of your income, or $15,000, might go toward entertainment and luxuries. Think: movie nights with friends, buying a guitar, and splurging on some new camping gear. (Those marshmallows won’t roast themselves!)

Here’s the math: Amount to spend on luxuries = After-tax income x 0.30

The last 20%, or $10,000, you could use for savings and investment. Again, this probably looks different from person to person — It might depend on whether you’re starting an emergency fund, saving to buy a car or home, or investing in the stock market.

The numbers: Amount to save or invest = After-tax income x 0.20

These percentages are rough guides. What works for one person might not work for another, and the exact amounts might not stay the same year to year. Plus, your needs, your wants, and your ability to save or invest will probably change as you grow older.

Still, this approach has the stamp of approval from Senator Elizabeth Warren. (She established the Consumer Financial Protection Bureau, and she wrote a book about this budgeting style with her daughter, Amelia Warren Tyagi.)

Keep in mind, the 50-30-20 rule works best for people with incomes that are about average for their location. It makes less sense for people with low incomes living in expensive areas, where it might be impossible to spend only 50% of your income on essentials. It also may not be ideal if you have a high income — In that case, you probably wouldn’t want to spend 50% of your income on necessities.

TL;DR: Spend 50% on your necessities and debt repayments. But this time, save 15% for retirement and set aside 5% for emergencies.

Here’s a variation that’s pretty similar: the 50-15-5 rule. This guideline suggests spending 50% of your income on living expenses and paying off debt. The next 15% can go toward saving and investing for retirement, and you might set aside 5% of your money for an emergency fund.

But wait! 50 + 15 + 5? That only adds up to 70%. You’re right!

How you spend (or save, or invest) the remaining 30% is up to you. You might notice that this guideline isn’t all that different from Warren’s 50-30-20 rule — It just divides the 20% bucket into distinct purposes: retirement and your emergency fund.

Another budgeting tip that remains popular is spending no more than 30% of your income on housing (aka your rent or mortgage). But this rule is a bit outdated — It originated in the 1960s as part of public housing requirements and it hasn’t been updated since then. Especially since real estate prices have risen and wages have stagnated, the 30% rule might not work anymore.

For your own purposes, you might get a sense of housing costs, or whether you’re getting a good deal, by comparing prices online. If you comparison-shop for smaller purchases, why not for housing?

Today, many millennials are spending a huge proportion of their income on rent. So, if you can find a way to optimize your rent (or mortgage), it might help you put away more money.

Managing your money kind of comes down to one question: Do you have more money coming in than you have going out? This is the fundamental principle that underlies whether you’re able to save and build your net worth over time. Let’s take a closer look.

Your income

When we talk about “income,” we’re referring to two kinds: gross income (before taxes) and net income (after taxes).

Gross income is your total pay, before taxes and deductions. This includes the wages you earn, the money you make from your side hustles, and even income from some savings or investment accounts.

Net income is what you get to take home, after taxes. When budgeting, it’s helpful to consider your net income because that’s the money you can actually use.

Your spending

Your spending generally falls into two buckets: your fixed costs (things you must pay for, often on a monthly basis) and your variable costs (things you want, which aren’t 100% essential).

For most people, their biggest fixed cost is housing. Other fixed costs might include debts, like student loans or car payments, as well as necessities like food and clothing. Your variable costs might include designer clothes or 4K Ultra HD TV.

We’ve started a sample list here:

Grab a sheet of paper and give it a shot. What’s on your list might be a little different. But it’s great to get a sense of your cost of living. Taken all together, these are your monthly expenses.

My Cost of Living = My Fixed Costs + My Variable Costs

To figure out your annual expenses, you can multiply your monthly expenses by 12. Then, if you divide your annual expenses by your annual net income, that’s the percentage of your money you spend each year.

My Annual Expenses = Monthly Cost of Living x 12

Percent of Income Spent = Annual Expenses / Net Income

If you can, try to build this into a routine. Once a month, grab a drink and calculate how much money you had coming in (aka your paycheck) and how much money you spent (using card statements, etc). It’s kind of fun to play detective, trying to remember what you bought. If you end up with more money than you spent, you built wealth that month. Then track your progress over time.

You might even catch a few questionable charges (e.g., subscriptions you don’t use anymore). If you find places to cut back, that’s money you’ll get to keep.

Also remember, your exact expenses will probably vary month to month, and it’s easy to overlook expensive, one-time purchases, like buying a new microwave or fixing the dishwasher. (When budgeting, you might divide these costs over twelve months.) Unexpected costs are also why a lot of people set up an emergency fund.

An emergency fund is a pool of money you don’t touch under normal circumstances. It’s available if the unexpected happens. You get into a car accident and need to pay medical bills, or you lose your job and still need to pay rent. While setting up an emergency fund can be difficult when you’re living paycheck-to-paycheck, the idea is to save something.

Some financial advisors recommend saving at least enough money to cover three months of your essential living expenses. Others recommend socking away enough for six months of expenses or more. You have to decide what’s right for you.

When it comes to investing for the future, you probably have competing priorities. Do you want to buy a home? Do you hope to retire? Some of your goals might be closer than others.

It’s tough to nail down an exact percentage to save or invest because your goals are unique to you. With that in mind, the American Association of Retired Persons (AARP) notes you should expect to spend 70 to 80 percent of your annual income per year in retirement. Keep in mind, starting early can make a big difference, especially with compounding returns.

Ultimately, budgeting is about figuring out what works for you and adjusting your approach to reach your goals. You might consider taking these next steps:

1. Write down your net income
2. List your expenses (your needs and your wants)
3. Subtract your expenses from your net income

If you’re left with a positive number, you’re probably adding to your net worth. If you’re left with a negative number, you might be accumulating debt.

Wherever you are today, it’s good to start measuring your money. This can help guide your spending, saving, and investing habits — and help you make an informed financial plan.