How Should Young Adults Divide Their Paychecks?

On Aug 1, 2023

I got the inspiration for this article after speaking with a 23-year-old unsure of how to divide his paycheck every two weeks. How much did he need to put in savings? How much of it should he invest? Where should he invest? These are all great questions, and the answers are unique depending on your lifestyle and age.

This article is for young adults still learning the ropes of financial independence. We hope readers will be inspired to take greater control of their spending habits and get started on making a savings plan if they haven’t done so already.

Key Takeaways

The 50/30/20 rule argues you should spend 50% of your paycheck on basic needs, 30% on wants, and 20% on debt repayment and savings.
It’s often a smart idea for young adults to invest in the stock market, as the market has always historically increased over a long enough period of time.
Young adults should start their retirement savings as soon as possible, and depending on when they want to retire, may want to save more of their paycheck than 20%.

Before Your Paycheck Arrives

If you’re a young adult and – like the guy I spoke to who inspired this article – feel a bit out-of-touch with your finances, your first step should simply be considering your situation. How much money do you make every month? How much do you spend on different things?

Download or print out a transaction history for your checking account. Go through the transactions and pick out the ones that are “needs.”

Some transactions may be a bit ambiguous. Eating out at a restaurant, for example, could arguably be a “need” since you need to feed yourself. But you could also reasonably say it’s a “want” since it’s often an activity done for pleasure. Use your own discretion to decide whether a purchase was done out of necessity or not.

Once you’ve determined how much (roughly) you need to spend per month, determine how much of your paycheck you currently dedicate to “needs.”

You may have heard of the 50/30/20 rule. The rule argues you should spend 50% of your income on needs, 30% of your income on wants, and 20% of your income on savings. This rule should be treated more as a guide than a law, and won’t be helpful to everyone. However, in an effort to be useful to as many people as possible, we’ll refer to it for this article.

We’ll discuss each of these categories in greater detail soon, but before getting your paycheck, simply find two numbers for yourself: how much you make per month, and how much you spend on recurring, necessary purchases.

Breaking Down Purchases

Let’s go into greater detail on the three spending categories covered above.

Needs

Purchases that can be considered “needs” might include groceries, utilities, rent, insurance payments, car payments, and minimum debt payments. I say “might” because part of dividing your paycheck involves deciding how strict you want to be with yourself.

A Netflix subscription, for example, may feel like a “need” for you. In that case, you should list it as such when breaking down your monthly transactions. For most young adults, just rent and utilities put them over the 50% mark. In that case, try a more strict thought exercise with yourself. What are things you could reasonably give up?

Wants

The “wants” category should be relatively self-explanatory. These are purchases that are not essential, but which you make for pleasure or enjoyment. We won’t tell you to give up things like alcohol, going out for dinner with your friends, or streaming services, just to direct more money into savings. These are the things that make life more pleasurable and exciting!

However, it’s sometimes important to take stock of how much money you direct toward fun. If you’re spending almost half your paycheck on basketball tickets, movies, and cigarettes, you’re sacrificing certain future comforts. Namely, greater financial security after retirement.

Savings

The savings section of spending includes more than just money in a savings account. You should build at least three months’ worth of emergency funds in case you lose your job. You may have to direct a minimum amount of money to debt repayment each month. Rather than put money in a savings account, maybe you already invest money into things like an IRA or the stock market.

All of these can reasonably qualify as money spent on savings.

The 80/20 Rule

If you find splitting your purchases into three different categories a bit too involved and unhelpful, you can think of the same principle with just two spending categories: savings, and everything else.

The 80/20 rule is another guide some people find helpful, which argues you should dedicate 20% of your paycheck to savings each month.

You’ll notice that both the 50/30/20 rule and 80/20 rule argue you should direct a fifth of your paycheck to savings. If you’re young and planning to retire at a typical age…