Guide

A Guide to the 50/30/20 Budget Rule

A Guide to the 50/30/20 Budget Rule
Written by Publishing Team

  • The 50/30/20 rule sets 50% of your income for needs, 30% for wants, and 20% for debt or savings.
  • Accurate tracking of your spending is critical to making a 50/30/20 budget.
  • This approach is best for people who get paid regularly and don’t have high-interest debt.
  • Read more stories from Personal Finance Insider.

Personal budgets are an organized way to make sure all of your financial commitments are met. They make it easier to plan ahead, spend responsibly and stay out of debt. However, there is no one budget method or any one plan that makes sense for everyone.

Although there are many options, the strategy that splits your income into three parts using the so-called 50/30/20 rule has become a popular choice for many people as they build their financial plans.

What is the 50/30/20 rule?

The 50/30/20 rule is a straightforward rule of thumb that involves dividing your spending into three distinct categories: needs, wants, savings, and debt payments. When calculating after-tax income, each specific category is assigned a specific percentage of your income.

According to the norm, 50% should go toward needs, 30% toward desires, and 20% toward savings and debts. “The nice thing about the system is that it’s simple,” says Jay Zygmont, Ph.D., certified financial planner, and founder of Live, Learn, Plan.

Needs: 50%

With this system, the needs are often minimal for survival: food, shelter, health care, basic clothing and other items of this type. “I really think that’s the core cost of living,” says Frank McLaughlin, a wealth advisor and CFB at Merriman. “It’s those things you can’t live without,” often taking a critical and honest attitude toward spending to figure out what really belongs in that category.

According to the 50/30/20 rule, no more than 50% of your after-tax income should go into this category. If your spending on “needs” represents more than half of your income, the idea of ​​the system is for you to cut back or adjust your lifestyle until you reach that limit.

wants: 30%

You want things you don’t need, but they make you happy and make your life more interesting. Anything from dining out to concerts, events, leisurely shopping, home upgrades, or vacations can fall into this category. They are things you can live without, but you would rather not. According to the 50/30/20 rule, these purchases should cost no more than 30% of your after-tax salary.

Saving and paying off debt: 20%

The last and smallest category is income that must be set aside for saving or paying off debts. This could mean paying off student loans, funding retirement accounts, paying off credit card debt, working toward long-term savings goals, or building an emergency fund.

“Either way, you increase your net worth either by saving more or putting money into your obligations or areas you owe money,” McLaughlin says.

Where did the 50/30/20 rule come from?

Senator Elizabeth Warren and her daughter Amelia Warren Tyagi, who wrote about 50/30/20 in their 2005 book, All Your Worth: The Ultimate Lifetime Money Plan, are widely credited with promoting its use in personal budgets.

Overall, the model keeps things simple, gives a general idea of ​​where the money might be going, and serves as a framework for tracking spending.

“It’s easy, it’s well organized – because of the obligatory savings component – and that’s why it’s so popular,” McLaughlin says of the reasons it has become so prevalent in the past decade and a half.

4 steps to applying the 50/30/20 rule to your budget

If you want to implement the 50/30/20 rule into your budget, experts recommend following four simple steps.

1. Know your monthly income after tax

Since the form is based on after-tax income, it is important to know what that number is. For most people, the easiest way to do this would be through their pay slips. Part of the reason it’s important to look at your pay stub, and not just the amount in your account, is that you’ll want to write down any contributions that will go into a retirement account or other savings plan.

“This can be seen as part of the 20% in savings, so you don’t want to underestimate yourself or denigrate all the work you do,” McLaughlin explains.

2. Calculate the amount to be spent in each of the three categories.

Next, you’ll need to calculate 50%, 30%, and 20% of your net salary to determine how much to spend in each category. To do this, multiply your after-tax salary by 0.5, 0.3, and 0.2, respectively. “It’s going to give you numbers that you can try to squeeze roughly into those different combinations,” says McLaughlin.

3. Carefully review and categorize your spending for the past month.

Once you know how much each bucket should represent in theory, take a look at where you actually spend it in practice. Going through the last few months of your bank statements and sorting each purchase is a good way to do this.

Knowing how much you currently spend on your wants, needs, savings, and debts will help you decide if you need to cut back or adjust in any areas.

4. Track your spending

To fully implement the 50/30/20 rule, you must track your monthly spending to make sure you stay under your tier limits. According to McLaughlin, this is often one of the toughest parts of the budget. As boring as it may be, it may discourage some potential users. A budget tracking app is one way to make the process simpler, but pencil and paper or spreadsheets can also help you keep track of your spending.

Is a 50/30/20 rule budget right for you?

Although the 50/30/20 rule can be a useful starting point, it is not always the best option for everyone. For example, retirees may not save 20%, or any money at all, once they stop working. It can also be difficult to implement for those who face irregular wages from month to month or year to year – such as contract workers or people who work primarily on commission.

“Not everyone will accurately fit these buckets,” says McLaughlin.

In some circumstances, the 50/30/20 rule may not be possible. If you earn less money, housing alone can take up half of your salary. Some people have loans already totaling more than 20% before the evening think about savings.

The rule also does not take into account interest, inflation, or any other factors outside the spending categories. If you have credit card debt with a high interest rate, it often makes sense to pay it off as quickly as possible before spending 30% of your income on desires.

“It will work best with people who have enough money and low enough debt to make it work,” Zygmont says. For people who don’t have any debt, low interest debt, or “good” debt, the rule might make sense. It can also be a good starting model for anyone who is completely new to budgeting and looking for a simple one.

“A budget is good to actually get you working on a tight budget,” Zygmont says. “If 60/20/20 turns out to be good, you’re at least using the budget. That’s what matters.”

About the author

Publishing Team

Leave a Comment