Money Management

The 50/30/20 rule for budgeting: Advantages and Disadvantages

The 50/30/20 rule is a way to allocate your budget according to three categories: Needs, Wants, and Financial Goals. It’s not a hard-and-fast rule but rather a rough guideline to help you build a financially sound budget. 

To better understand how to apply the rule, we’ll look at its background, how it works, and its limitations, and we’ll go through an example. In other words, we’ll show you how and why to set up a budget using the 50/30/20 rule yourself.

What Is the 50/30/20 Rule?

The 50/30/20 rule of thumb is a set of easy guidelines for how to plan your budget. Using them, you allocate your after-tax income to the following categories.

50% to Needs

Needs are what you can’t live without, or at least not very easily. They include things like:

  • Rent
  • Groceries
  • Utilities, such as electricity, water, and sewer service

30% to Wants 

Wants are what you desire but don’t actually need in order to survive. They might include:

  • Hobbies
  • Vacations
  • Dining out
  • Digital and streaming services like Netflix and Hulu

20% to Financial Goals

This category covers two main areas:

  • All savings, such as retirement contributions, saving for a house, and setting money aside in a 529 college savings plan (note that contributions to a 401(k) come from your pre-tax income)
  • Debt payments

Because this is just a guideline for planning your budget, you’ll need to supplement it with something to monitor spending, such as a budget tracker like YNAB (You Need a Budget), Mint, or Quicken. You can then set the 50/30/20 percentages as targets within whichever budget tracker you prefer.

Where Does the 50/30/20 Rule Come From?

The 50/30/20 rule was popularized by Senator Elizabeth Warren (a Harvard law professor when she coined the term) and her daughter, Amelia Warren Tyagi, in the book All Your Worth: The Ultimate Lifetime Money Plan. It was designed as a rough rule of thumb for working-class families to plan their spending in order to prepare for the future and unforeseen circumstances.

Also Read: How insurance protects you from Financial loss

How to Use the 50/30/20 Rule for Budgeting

Most people save too little, and unknowingly spend too much. The 50/30/20 rule of thumb is a way to become aware of your financial habits and limit overspending and under-saving. By spending less on the things that don’t matter that much to you, you can save more for the things that do.

Here’s how it works:

  1. Calculate your monthly income: Add up how much you receive in your bank account each month. If you have a workplace retirement plan, find out how much is withheld, and add that amount back in with your take-home pay. If you pay estimated taxes, reduce your monthly income amount accordingly.
  2. Calculate a spending threshold for each category: Multiply your take-home pay by 0.50 (for needs), 0.30 (for wants), and 0.20 (for financial goals) to see how much you should ideally spend in each category. 
  3. Plan your budget around these numbers: Think of these three categories as “buckets” that you can fill with monthly expenses. List and tally your monthly expenses under the category that each falls into and see whether you’re spending less than the monthly targets you established in the prior step.
  4. Follow your budget: Track your expenses each month, and make changes where needed, in order to stick to your spending thresholds going forward.

Also Read: Budgeting: getting out of debt and tracking expenses

An Example of the 50/30/20 Rule

Here’s an example using the steps above:

  1. Calculate your monthly income: Let’s say you and your spouse have a total of $4,787 deposited into your bank account each month from your jobs. You both check your pay stubs and see that a total of $532 was taken out for 401(k) contributions. This means that together, your monthly income is $5,319 ($4,787 + $532).
  2. Calculate a spending threshold for each category: Based on the 50/30/20 rule, the amount you should allocate to “needs” is $2,659 ($5,319 x 0.50). The amount you should allocate to “wants” is $1,596 ($5,319 x 0.30). The amount you should allocate to financial goals is $1,064 ($5,319 x 0.20). Since you’ve already contributed $532 to your 401(k)s, use the remaining $532 to pay down debt or save for other financial goals. 
  3. Plan your budget around these numbers: Go through your budget to either plan out your spending or see how well it is already aligned with these targets. 
Total Monthly Income$5,319
Needs: $5,319 x 0.50$2,659
Wants: $5,319 x 0.30$1,596
Goals: $5,319 x 0.20$1,064

Why the 50/30/20 Rule Generally Works

Figuring out your finances is confusing, and it’s often hard to know where to start. That’s one reason the 50/30/20 rule of thumb works so well: It’s an easy way to get a handle on something that can otherwise be intimidating.

Even if you don’t take it any further by tracking how well you stick to these targets, it’s still a good way to take your financial pulse.

Grain of Salt

Like any rule of thumb, it’s a good idea to take the 50/30/20 rule of thumb with a grain of salt.

Potential for Gray Areas

It’s sometimes hard to sort out your spending according to three categories. Everyone needs to eat, for example, but some groceries fall into the wants category (like sugary sodas and unhealthy snacks). 

Can Be Difficult for Low-Income People

If you’re earning just enough to make ends meet, you may struggle to save 20% of your income regardless of how you live, especially if you’re supporting a family. 

Savings Might Not Be Enough

On the flip side, if you have big goals, like retiring early or buying a house in a high-income area, 20% might not be enough. 

For example, the average home price of a house in San Francisco was more than $1.6 million in June 2022. You would need to save, on average, $320,000 to afford a 20% down payment there. Your down payment would be more than 70% of the total cost of an average-priced home nationwide in 2021.

You Still Need to Track Your Budget

The 50/30/20 budget rule is only one piece of the budgeting puzzle. It’s good to shoot for these percentages, but unless you track your spending, you’ll never know whether you’re actually hitting them.

Also Read: How to avoid financial fraud and protect your investments

The 50/30/20 Rule vs. Other Budgeting Methods

The 50/30/20 rule of thumb isn’t the only game in town. Here are a few other budgeting techniques that might work better for you:

  • The 80/20 Rule: With this method, you immediately set aside 20% of your income for savings. The other 80% is yours to spend on whatever you want, with no tracking involved. 
  • The 70/20/10 Rule: This rule is similar to the 50/30/20 rule, but you instead parse out your budget as follows: 70% for living expenses, 20% for debt payments, and 10% for savings.

Frequently Asked Questions (FAQs)

How does tithing figure into the 50/30/20 rule?

As with any rule of thumb, you’ll need to adjust it to fit your specific circumstance. When it comes to tithing or any other religious expense, individuals can decide for themselves whether that’s something they “want” or “need.”

Where does credit card debt go in the 50/30/20 rule?

Paying down debt is considered a financial goal. That means you should allocate 20% of your budget toward some combination of paying down debt and saving for the future.

How much of your paycheck should you spend with the 50/30/20 rule?

The 50/30/20 rule doesn’t specify how much of each paycheck you should spend. The percentage of your paycheck that you spend or save largely depends on the 20% financial goal category. If your main financial goal is to reduce debt, you’ll be spending more of your paycheck on that. If your main financial goal is to save up an emergency fund, then you’ll be saving more of your paycheck.

So where do you start?

To begin with, the 50/30/20 budget, calculate your after-tax income on average. You can do exact amounts or round down to the nearest dollar. Once you have that number, split it into the allotted percentages to get each category’s maximum budget.

Then take a look at your spending habits over the past couple of months and start identifying which segment those particular expenses fit into. Be mindful that this is a guideline and not an absolute. For each expense, ask yourself, “Was it a need or a want?” and come up with subcategories they can live under for your budget. It’s also recommended that you round up your utility expenses to the nearest $5 to anticipate heavier usage months.

Once that’s complete, how do your expenses measure up to each category? Are there any expenses that you can potentially recategorize, or should you tweak the percentages to better suit your situation?

Next, identify easy, low-hanging opportunities to save. For example, do you have too many streaming services? Can you share accounts with your roommates and split them 50/50?

Once you think you’re set, test-drive your new budget for 2-4 weeks to see if it’s liveable. If a budget is not liveable, you won’t stick to it, so it’s crucial you find a balance that will work for you beyond the short term.

The Bottom Line

Saving is difficult, and life often throws unexpected expenses at us. By following the 50-20-30 rule, individuals have a plan with how they should manage their after-tax income. If they find that their expenditures on wants are more than 20%, they can find ways to reduce those expenses that will help direct funds to more important areas such as emergency money and retirement.

Life should be enjoyed, and it is not recommended to live like a Spartan, but having a plan and sticking to it will allow you to cover your expenses, save for retirement, all at the same time doing the activities that make you happy.

Originally posted 2022-06-13 04:13:02.

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