50/30/20 Rule: Budgeting That Works
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Summary:
The 50/30/20 rule is a model meant to streamline your budget into three spending categories based on percentages. To put the budgeting system into practice, you calculate your net monthly income and then allocate your spending accordingly: 50% for needs, 30% for wants, and 20% for savings or paying down your debts. The 50/30/20/rule was popularized by the book All Your Worth: The Ultimate Lifetime Money Plan, written by U.S. Senator Elizabeth Warren and her daughter, Amelia Warren Tyagi. However, the concept had been around for some time and has been promoted by other financial experts also.
If you’ve never designed a household budget before, it might feel like a complicated task. It might also seem like there will be math involved as well as some tough decisions. Well, to be honest, that’s all partly true.
However, it doesn’t have to be as tricky as you might think, and it can help you to manage your money more efficiently and effectively. Read on to learn more about the 50/30/20 rule, how it works, and how it can help you to reach your financial goals, no matter what they might be.
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What is the 50/30/20 rule?
The 50/30/20 rule is a budgeting model that encourages you to divide your spending into three categories: needs, wants, and (cumulatively) saving, investing, or repaying debts. The first 50% is meant for your immediate needs to live — mortgage, car payments, and other necessary monthly bills — 30% is for your wants, and 20% should be saved, invested, or used to make additional payments on debts. Get a feel for how the system works by using the 50/30/20 calculator below.
One of the nice things about this budgeting method, over more complicated models, is that rather than tracking every penny you spend, it allows for only three major categories of expenditures. That can make it easier for beginners to learn to manage their cash more successfully and save for future goals without getting overwhelmed.
Pro Tip
“To make budgeting really stick, schedule time to review it on a regular basis (at least monthly). If you’re part of a couple, make sure to set your goals AND review the budget together. You will find you’ll modify goals, income and expenses over time,” says Kyle Enright, President at Achieve, a digital personal finance company.
50% for needs
Your needs encompass everything you can’t live without and should take up no more than half of your after-tax income. For instance, if your monthly take-home pay is $4,000, you should spend no more than $2,000 on everything you need to get by.
These necessities may vary a bit from person to person depending on their unique situations. However, basic needs usually include monthly expenses such as the following.
- Rent or mortgage payments
- Car payments
- Transportation costs such as gas or train passes
- Utilities like gas, electric, and water
- Health insurance and other types of insurance
- Health care costs not covered by insurance
- Cell phone bills
- Minimum debt payments
- Groceries
As you assess your monthly living expenses, you may find that more than 50% of your monthly after-tax income is going toward your needs. This is a common problem and it could be because of your income level, where you live, or other factors.
Pro Tip
In this case, you might want to think about some changes you could make to lower your expenses. For example, you could look into a cheaper cell phone plan or switch your car insurance. In more extreme cases you might need to think about scaling back your lifestyle, like finding a less expensive apartment to rent or downsizing your wants to make up the difference.
30% for wants
According to the 50/30/20 rule, less than a third of your after-tax income should be spent on things you purely want. While it can sometimes be hard to objectively distinguish between your wants and your needs, wants are defined as things you like to do or have but don’t need to survive. Sorry, but the latest cell phone is a want, not a need.
Other wants include:
- Eating in restaurants
- Gym memberships
- Buying gifts
- Cable TV or streaming services
- Vacations
- Tickets to concerts or sporting events
Basically, any unnecessary spending is on things you want but don’t need. Sticking with the previous example of earning $4,000 a month, this means you should spend no more than about $1,300 a month on things you want. If you find that you’re using more than that, you might need to pare down on a few things.
The good news is that this is one of the easiest ways to save money. The bad news is, you can’t do everything you want to do. Think about working out at home instead of paying for a gym membership, cooking at home more often, watching football games on TV, or cutting down your streaming services.
20% for savings and debt payments
The remainder of your after-tax income, 20%, should be used for savings and/or paying off your debts. Minimum payments on your existing debt are included with your needs, but this category would include any extra payments aimed at debt reduction.
Reducing your debts, particularly high-interest credit card debt, should be one of your top priorities. Other financial goals might include:
- Building an emergency fund in your savings account
- Retirement contributions
- Down payment on a house
- Investments
- Saving money for college
- Home improvements
Sticking with our earlier example, if you make $4,000 in post-tax income, $800 of that should be for your debt repayment, investment, or savings goals. This category can look different for different people, and it really depends on your individual goals for now and in the future.
“First and foremost, set and write down short-term and longer-term goals – with spouse and family if applicable,” advises Enright. “Write them down, and then build the budget around those goals. You’ll revisit and modify both goals and budget month to month, year to year, throughout life, but approaching budgeting this way will dramatically up the chances you’ll stick to the budget — and allow you to achieve your goals.”
Pro Tip
Before you start saving for a vacation or a new car, prioritize money to allocate for debt payments, savings for emergency funds, and retirement. Whether you’re saving through an employer-sponsored retirement plan or an individual retirement account (IRA), this is one of the most important things you can do for your future.
One of the best ways to start building a retirement or emergency fund is through a high-yield savings account. These accounts, like the ones below, allow you to earn more interest on your savings than a normal savings account.
Putting the 50/30/20 rule into practice
Now that you understand how the 50/30/20 rule works, it’s time to get organized and put the budgeting system into practice. You can make this as relaxed or as structured as you like — just tailor it to your particular needs.
Calculate after-tax income
For full-time W-2 employees with a steady paycheck (meaning your employer takes deductions from your paycheck for you), this is pretty straightforward. Just take a look at your pay stubs — or your bank statement if you do direct deposit — and see how much goes into your bank account each month. That’s your take-home income and the basis for your budget.
For those who are self-employed, you’ll have to do the math yourself, but it’s not difficult. Just take the amount you earn each month and subtract the money you need for business expenses plus what you put away for taxes. Whatever you have left is your budget for the month.
If you have multiple jobs, you’ll need to add up the take-home pay from each one and total them all together to arrive at your combined take-home income.
Figure out your expenses
In order to plan your budget and follow the 50/30/20 rule, you’ll need to know what you spend every month in each of the three categories: needs, wants, and savings/additional debt payments.
“Keep it simple with whatever works for you: app, spreadsheet, online program, (or) pencil and paper,” Enright suggests.
Whichever method you choose, you’ll want to add up your spending in each category to see where you fall within the 50/30/20 rule. Keep in mind that half of your money is for needed living expenses, 30% is for luxuries, and the rest is meant to be saved, invested, or used to pay down your debts.
If you prefer to keep everything digital, you may want to consider using one of the money management tools below.
Evaluate and adjust your budget
Now that you know how much you spend each month, you can start to see the big picture of your financial situation and where you might need to make some adjustments. For instance, if you see you’re spending too much on wants or needs or too little on savings, you can modify your spending habits accordingly.
You’ll also want to compare your total expenditures against your total monthly after-tax income. If you’re spending more than you make, you risk getting into an endless cycle of debt.
“If total expenses total more than income, there is no magic or instant solution. You must find a way to reduce expenses or increase income,” Enright points out.
Is the 50/30/20 rule a good idea?
Creating — and sticking to — a budget is always a smart move, but it doesn’t necessarily have to be the 50/30/20 rule. For some people, having only the three spending categories to track can feel less overwhelming than recording every individual expense you have.
On the other hand, some individuals may find that a budget system that’s a little more structured is a better fit for them. It’s important to remember that when it comes to making a budget, there is no one-size-fits-all approach.
The main thing to focus on is having a budget plan that helps you pay your bills and meet your investment and savings goals, says George Kamel, a personal finance expert at Ramsey Solutions.
Savings tips
Putting away cash for a rainy day or a large expenditure can be challenging, but it’s less daunting if you start small. As you watch your money grow, you’ll be more motivated to save and identify new ways to cut back on your expenses.
- Use round-up apps. There are many financial tools on the market that can help you to save and invest your money, starting with very little. Round-up apps work by linking to your bank account and every time a transaction is processed, the “spare change” is deducted and added to your investment account. For instance, if your electric bill is $79.02, 88 cents is added to your round-up account.
- Take automated deductions from your paycheck. Sometimes it’s easier to save money if it never passes through your hands. Consider having a little cash automatically deducted from your check at each payment period. You could start with as little as $20.
- Reprioritize your wants. Pick one thing that you enjoy, but don’t need, and allocate that money to your emergency fund or other savings goal. Think of simple things, like making coffee at home, deleting one streaming service, or canceling your gym membership during the warmer months.
FAQs
What’s the 70/30 rule?
The 70/30 rule is a simpler type of budgeting model that says you should use 70% of your after-tax income for all of your expenses, including both your needs and your wants. If you find your monthly expenses exceed 70% of your pay, then you’ll need to cut back on some areas. The remaining 30% is then earmarked to pay debts, save, or invest.
How much savings should I have at 40?
Conventional wisdom suggests you should have about three times your salary saved by the time you’re 40 years old. For instance, if you’re making $50,000 a year, you should (theoretically) have $150,000 saved or invested.
But don’t panic if this isn’t true for you yet. You still have plenty of time before you retire to make up for any difference. One great tool is to maximize your contributions to an employer-sponsored retirement account or open a traditional or Roth IRA to accumulate additional funds for your post-working years.
Key Takeaways
- The 50/30/20 rule is a budget system designed to help you track and adjust your expenditures into three main categories: needs, wants, and savings and debt.
- The budget rule suggests you spend 50% of your after-tax income on needs like rent and utilities. You then allocate 30% for wants such as dining out and 20% on savings, investing, or paying off debt.
- As you evaluate where your money goes, you can make adjustments in different areas so as to increase or decrease your spending habits in the various categories.
- Paying off your debts as quickly as possible, creating an emergency fund, and saving for when you retire are three important goals that a budget system can help you reach.
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