Table of Contents:
- What is the 50/30/20 Rule?
- Elements of the 50/30/20 budget rule
- How to budget with the 50/30/20 rule
- How does this compare to the 70/20/10 rule?
- The bottom line
Managing our money effectively means having a good understanding of financial literacy, which is the knowledge and skills that allow us to use all our financial resources to make informed decisions about our financial life.
A key component of financial literacy is budgeting our money. Despite the fact that many methods make it complicated and overwhelming, it doesn’t have to be. A simple solution to budgeting is known as the 50/30/20 rule and may forever change the way you feel about creating a budget.
What is the 50/30/20 Rule?
We’ve all experienced budgeting advice that makes us want to give it all up and forget it. We’re told to obsessively track income, spending, and debts on a spreadsheet and not to spend a penny without reviewing it.
We’re told to cut expenses to the bone, so we don’t overspend and to live modestly, which means no shopping, entertainment, or dining out. And we’re told to skip gift giving and vacations. It makes you wonder what you’re working for and if you’ll ever be able to enjoy life.
Fortunately, there’s another way. In 2006, Harvard Law Professor and Senator Elizabeth Warren and her daughter, Amelia Warren Tyagi, published their book: All Your Worth: The Ultimate Lifetime Money Plan, which changed the way we think about money and budgeting by introducing the 50/30/20 budget plan.
In the book, the plan focuses on the 50/30/20 rule and how it can simplify how we budget our money in a balanced and healthy way to pay all our bills, be aware of our spending habits, and still enjoy life.
The 50/30/20 rule states that we take our after-tax income (our take-home pay) and allocate 50% to needs, 30% to wants, and 20% to savings.
Key Takeaways:
- The 50/20/30 rule for budgeting simplifies how we manage our after-tax money to meet all of our financial goals.
- The personal finance rule states that 50% of our money goes to needs, 30% to wants, and 20% to saving goals.
- The rule helps us balance our financial obligations while giving us the freedom to enjoy living in a way that doesn’t overcomplicate finances.
- A savings plan and money for investing are built-in, so we can put money away over the long-term for retirement and protect our money from rising inflation rates.
Elements of the 50/30/20 budget rule
The guidelines for the 50/30/20 rule are relatively simple and meant to be used as a rule of thumb for planning and managing your budget. The beauty of the plan is that you only need to divide your expenses into 3 main categories.
Doing this can eliminate the complex details of most budgets and focus on the big picture, making it a quick and easy resource to use. Here’s how it works:
50% needs
To put it simply, needs are those living expenses you have to pay so you can live life. They are essentials we need every day and include:
- Housing (mortgage payment or rental payment)
- Utilities, such as water, sewer, electricity, and gas
- Car payments or other transportation expenses
- Insurance for healthcare, car, and pets
- Minimum payments on loans
- Groceries
30% wants
Wants include those non-essential items that are nice to have but not necessary to live comfortably. They include:
- Eating out
- Vacations
- Entertainment
- Shopping
- Gym memberships
- Hobbies
This category will also include upgrades, such as movie channel subscriptions, extravagant restaurants, designer clothing, and expensive vehicles. Basically, they are the things that we don’t need.
20% savings
The 20% is allocated for any type of savings goal, including:
- Retirement contributions such as to a 401(k), IRA, or other investment accounts
- Emergency funds (it’s recommended to strive to save 3 months of living expenses)
- College funds
- Debt repayment
By saving 20% each month, you can give yourself a safety net for unforeseen financial emergencies, use it for future plans, such as a downpayment on a home, or pay off that high-interest debt.
How to budget with the 50/30/20 rule
In order to set a budget using 50/30/20, we’ll need to get our numbers. As we know, what we earn from our job is not what we deposit into our bank accounts.
Before we even see our earnings, deductions are taken out, such as state and local taxes, medical insurance and/or Medicare costs, Social Security, and if you have a 401(k), those contributions will be deducted as well.
What we’re left with is our after-tax income, otherwise known as our take-home pay. So, how do we create a budget?
Step 1. Calculate your monthly income after taxes.
Add up how much money is deposited into your account each month. For example, if you get paid bi-weekly, you’ll receive 2 paychecks most months. Total them together for your monthly budget baseline.
If you have retirement savings and health insurance benefits deducted from your paycheck, note that deduction amount and add that back in. It will be included in your savings category.
Step 2. Calculate the spending according to each of the 3 categories.
Next, multiply your take-home pay (the total of all your paychecks) by 0.50 for your needs allocation, 0.30 for your wants allocation, and 0.20 for your savings allocation. This is the basis for your 50/30/20 budget plan.
Step 3. Plug in your spending/monthly expenses into these categories.
You can think of the categories as 3 separate columns that you’ll put each of your monthly expenses under. Go through each one of your bills or financial responsibilities and put them each in the appropriate category. Once they’re listed, add up the amounts due and see if your allocation covers those bills for each category of needs, wants, and savings. If you deducted your 401(k) contribution, you’d add that into your savings column.
Step 4. Follow the budget plan.
Track expenses to stay on track and make any adjustments needed to stay within your budget categories.
Now, let’s use some real numbers to show you how it all comes together.
Let’s say Mary’s take-home pay is $5,000 a month. Using the 50/30/20 budgeting rule, her plan looks like this:
- 50% needs = $2,500
- 30% wants = $1,500
- 20% savings = $1,000
Mary’s 50%
- Mortgage payment + homeowners insurance – $1,495
- Car payment + insurance – $370
- Utilities – $120
- Student loan – $350
- Groceries – $250
Total = $2,585
Mary’s 30%
- Cell phone – $125
- Internet – $75
- Streaming services – $35
- Dining out – $300
- Entertainment – $250
- Shopping – $185
- Gym membership – $24
Total = $994
Mary’s 20%
- 401(k) – $500
- Emergency fund – $300
- Extra student loan payment – $200
Total = $1,000
If we look at Mary’s allocation amounts for her needs (50%), wants (30%), and savings (20%) goals, you can see that she’s basically on track and taking care of all her financial obligations with a little wiggle room in her wants category, which she can cover the little bit of overage in her needs category and then add the rest to extra debt payments or savings.
How does this compare to the 70/20/10 rule?
Both the 50/30/20 rule and 70/20/10 rule are easy budgeting techniques that keep finances well organized. Due to fewer categories, you won’t spend hours painfully putting all your spending into endless spreadsheets while attempting to figure out how to stay on track.
Although they are similar in their approach, allocations differ. We’ve discussed the 50/30/20 rule, so here’s what the 70/20/10 rule looks like:
With this budgeting method, 70% of your take-home paycheck is allocated to spending on needs and wants, 20% goes to savings and investing, and 10% to extra debt payments and giving.
70% includes housing, such as a mortgage or rental payments, utilities, health care expenses, insurance, car payments, monthly bills, loan debts, dining out and groceries, shopping, recreation, vacations, and any other expenses that would be considered a need or a want.
20% is allocated to investment and retirement accounts, such as a 401(k), IRA, or other savings accounts, which may include a sinking fund. A sinking fund is for saving for more considerable expenses and emergencies.
10% should be used to pay additional college loans, save for a down payment, pay down your mortgage or credit card debt, or for donations of any kind and extras such as gifts.
Using either method takes the confusion out of budget planning. Either can be perfect for all income levels since they each use percentages instead of dollar amounts. It can work for any experience level, even for beginners.
FAQs about 50/30/20 & budgeting
Q: Where did the 50/30/20 rule come from?
A: It gained popularity when Harvard Law Professor and Senator Elizabeth Warren and her daughter, Amelia Warren Tyagi, wrote the book, All Your Worth: The Lifetime Money Plan. With 20 years of research behind their findings, they wrote about how a simple budgeting plan would offer a balanced way to organize your finances for a lifetime.
Q: Does the 50/30/20 plan allow for my investments?
A: All of your investments would go into the savings category, including investing in stocks, bonds, mutual funds, and any other type of retirement or savings account.
Q: Where will I put my student loan debts?
A: Student loans are considered a need since they are part of your required monthly payments and can negatively impact your overall credit score.
The bottom line
We shouldn’t have to spend endless hours organizing our finances, and by using the 50/30/20 rule, you won’t have to. It allows us to balance our income and expenses, so we can live our lives and save at the same time, without worrying about outside factors like inflation impacting our investments.
Join our investing community, and start investing by downloading the Public app.
