Finance

The 50/30/20 Rule for Budgeting Your Money


Person inputting numbers on a calculator.
The 50/30/20 rule for household budgeting.

What Is the 50/30/20 Rule?

The 50/30/20 rule is a percentage-based budgeting method designed to help you manage money easily and effectively. To use it, divide your monthly after-tax income into three categories: 50% for needs, 30% for wants, and 20% for saving or paying off debt.

With just three main spending categories, you can ensure you pay all your bills on time, have money to do the things you want, are getting out of debt, and increase your savings.

As simple as it is and as great as it sounds, it’s not a one-size-fits-all solution. Find out if the 50/30/20 rule will work for you.

Why Use the 50/30/20 Rule to Budget Your Money?

Having only three expense categories to track with a 50/30/20 budget simplifies the budgeting process. You don’t have to be as meticulous about tracking every expense and it isn’t as time-consuming as other budgeting methods. The simplicity makes it easier to stick to for some people.

If you spend first and then save whatever random amount you have left at the end of the month or you have trouble saving at all, the 50/30/20 budgeting system could also help you increase your savings. If you’re looking for a simpler budgeting approach, this type of budgeting system could work for you.

How To Budget With the 50/30/20 Rule

50 30 20 pie chart for household budget.
50/30/20 pie chart.

The 50/30/20 rule makes budgeting easier by allocating your after-tax income into three spending categories: needs, wants, and savings or debt. Here is how the 50/30/20 rule works:

50% for Needs

Needs are your essential living expenses. Needs are comprised of fixed expenses, obligations you must pay, and things you need to survive. Examples of needs include:

  • Mortgage payments or rent
  • Groceries
  • Health insurance
  • Basic clothing
  • Insurance
  • Child care costs
  • Basic utilities
  • Auto loan payments and other transportation costs
  • Minimum debt payments

Think of needs as basic living expenses or bills you are contractually required to pay. Needs do not include discretionary spending or extras like restaurant meals, entertainment, or weekend getaways.

It can be difficult to lower your monthly expenses by spending less on needs, but it can be done. For example, you might switch to a cheaper car insurance policy, find ways to lower your housing expenses, or get a new cell phone plan.

If your needs and financial obligations exceed half of your take-home pay, it doesn’t necessarily mean that the 50/30/20 system doesn’t work for you. Decide if spending less on your wants, eliminating bad spending habits, increasing your income, or making lifestyle changes is necessary.

30% for Wants

Wants are non-essential expenses you spend money on but could live without. Things like:

  • Gym memberships
  • Streaming services like Netflix and other monthly subscriptions
  • Leisure travel
  • Starbucks
  • Hobbies
  • The latest electronic gadget
  • Other discretionary spending

Wants may make things easier, more fun, or improve your quality of life. They aren’t essential to survival, however.

20% for Savings and Debt Repayment

Devote 20% of your net income to savings. This includes investments, your emergency fund, and retirement savings.

The savings category also includes paying off debt. Minimum payments go in the needs category, but any extra payments you make as part of your debt payoff strategy lower your balance and reduce the interest you pay, so they count as savings.

One of the biggest benefits of using the 50/30/20 rule and other percentage-based budgeting techniques like it is that saving money is built in. By dedicating a fixed percentage of your earnings to savings, you can rest assured knowing that money is going toward your future financial goals every month. That could represent a stark change if you’re using another budgeting system or your monthly savings are an afterthought.

You can further divide the 20% savings bucket into short-term savings, long-term financial goals, and getting out of debt. You might prioritize:

  • Paying off your credit card debt
  • Emergency savings
  • Saving for a down payment on a house
  • Building your college savings fund
  • Retiring your student loan debt
  • Saving for retirement

You could then put more of the 20% toward your primary savings goal.

50/30/20 Rule Example

Here is a 50/30/20 budget example:

Suppose you are a single person who contributes to an employer-sponsored retirement plan. After payroll deductions for health insurance, a 401k contribution of $184 per month, Social Security, Medicare, and state and federal taxes, your net monthly income is $2,400.

Based on the 50/30/20 rule, your budget would look like this:

  1. Needs: $1,200 ($2,400 x 0.50) for needs.
  2. Wants: $720 ($2,400 x 0.30) put toward nonessential spending.
  3. Savings and Debt Reduction: $480 ($2,400 x 0.20) goes to savings and paying off debt. Since $184 in retirement contributions were already made, the remaining $296 ($480 – $184) can be used for getting out of debt, funding retirement accounts, making additional savings contributions, or other future goals.

Now that the rule has been applied to your post-tax income, the next step is to create your spending plan using these numbers.

Gather up your bank statements, utility bills, and all other bills then review your spending.

If your expenses don’t align with the target percentages and you want to stick with a percentage-based budget, you can:

  • Adjust the percentages
  • Cut expenses
  • Increase your income
  • Implement some combination of the above

For example, you might:

  • Bump needs up to 60% and lower wants to 20%
  • Take on a second job or side hustle
  • Negotiate lower interest rates with creditors
  • Use public transportation more
  • Find ways to reduce your housing costs

You don’t have to treat 50/30/20 as a hard-and-fast rule that can’t be modified to better suit your financial situation and goals.

Pros and Cons of the 50/30/20 Budget System

If you’re looking to create your first budget or keep your finances in check, the 50/30/20 method could clarify your financial picture and work well for you. It’s not without flaws, however.

Here are the advantages and disadvantages of using a 50/30/20 rule budget:

50/30/20 Rule Pros 50/30/20 Rule Cons
Can be easy to start and stick to Doesn’t account for individual circumstances 
Savings is built in Saving 20% of income might be unrealistic
You don’t need to track every purchase You can lose track of where your money goes
Not overly restrictive Hard to sort expenses into just 3 categories
Allows for spending on wants Too much goes to unnecessary spending

Frequently Asked Questions (FAQ)

Here are some answers to frequently asked questions about creating a 50/30/20 plan for your money:

Who created the 50/30/20 rule?

Elizabeth Warren and her daughter Amelia Warren Tyagi created and popularized the 50/30/20 budget rule in the book All Your Worth: The Ultimate Lifetime Money Plan, which they co-authored. The 50/30/20 budgeting method divides post-tax income into three categories: needs, wants, and savings/debt repayment.

Does 401(k) count towards the 20% savings?

The 50/30/20 rule has you divide your monthly after-tax income into three budget categories: 50% for needs, 30% for wants, and 20% for saving or paying off debts. The savings bucket would include contributions to your 401(k) or IRA.

Is the 50/30/20 rule before or after taxes?

The 50-30-20 rule of budgeting says that you should spend 50% of your after-tax income on needs, 30% on wants, and 20% on savings and debt repayment. 401(k) deductions are taken out before taxes but count toward the 20% savings target.

Is the 50/30/20 rule realistic?

The 50/30/20 budget works for some people. It can be realistic if your income covers your needs and your cost of living is reasonable. The 50/30/20 system is unrealistic for those with a low income. It won’t be a good rule for people who live in expensive areas or cities like New York and San Francisco.

Is the 50/30/20 rule good for budgeting?

The 50/30/20 rule can be great for people who lack the time or patience to track their spending in detail. The 50/30/20 rule divides expenses into just three categories: needs, wants, and savings or debt. The 50/30/20 rule is also good for people who have trouble saving money, as savings are built in.

Final Thoughts on the 50/30/20 Rule of Thumb for Budgeting

Budgeting is an important part of a long-term financial plan. The 50/30/20 rule is a simple budgeting strategy that divides your net income into three budgeting categories: needs, wants, and savings or debt reduction.

The 50/30/20 rule of budgeting can improve your financial health, especially if you don’t have a monthly budget or don’t know where your money goes. It is not an approach that works for everyone, though.

If you use the 50/30/20 rule, you might need to adjust the percentages to fit your financial circumstances or make changes to your spending and lifestyle. You also still need to track your spending to ensure you’re not exceeding your spending thresholds.

Featured Image Credit: Unsplash. Infographic courtesy of KindaFrugal.com.



Source link