New to managing your finances? Struggling to setup or stick to a budget? Try implementing the 50/30/20 rule.
Budgeting Made Simple
Budgeting doesn’t need to be complicated, and it shouldn’t take hours to implement. A lot of times the best ways to budget are the simplest. The 50/30/20 rule is a basic, straightforward monthly budgeting method that tells you exactly how much to put towards your living expenses, savings goals, and fun money.
To be clear, the 50/30/20 rule isn’t really a rule but more of a guideline for setting up budgeting. It gives a simple, clear, big-picture view of your monthly budget. It can help you avoid overspending and keep your goals on track without having to painstakingly record every single transaction.
I consider it a guideline because any budget needs to be adjusted for a person’s particular goals. There is no such thing as a one-size-fits-all approach since each person has unique financial goals. For example, if your goal is to save for a house down payment, adjust the ratios to 40/20/40. Don’t be hamstrung that there is only one way to do things.
Now let’s learn more about what the 50/30/20 rule really is and how it benefits you.
What is the 50/30/20 Rule?
The 50/30/20 rule came from U.S. Senator Elizabeth Warren’s (and her daughter Amelia Warren Tyagi) 2005 book, “All Your Worth: The Ultimate Lifetime Money Plan.” In the book, they referenced over 20 years of research to conclude that a complicated budget is not needed to get finances on track. All that is needed is to balance your money across a person’s needs, wants, and savings goals.
This is where the 50/30/20 rule comes in.
The basic rule of thumb is to divide your monthly after-tax income into 3 basic categories: 50% for needs, 30% for wants, and 20% for savings goals. See the picture from mintnotion.com below for a pictorial view of the 50/30/20 rule.
By regularly keeping expenses balanced across the 3 main spending categories, your money is put to work more efficiently. Since there are only 3 categories to track, time and stress is saved by not forcing yourself to dig into the details every time a transaction occurs.
It also builds a basic and uncomplicated structure into spending habits. Keeping things simple enables good financial habits to be developed and adhered to over a long period of time. This is because knowing exactly how much to spend on each category makes it easier to keep your spending in check.
Here’s what a budget that adheres to the 50/30/20 rules may look like:
50% Of Monthly Money for Needs
What are defined as “needs”? Simply put, needs are essential expenses that cannot be avoided no matter what and difficult to live without.
Needs may include:
- Mortgage / Rent
- Utility Bills
- Transportation
- Groceries
- Insurance
- Minimum Loan Repayments (i.e. auto, credit cards, personal loans, etc.)
- Medical Bills
Now why would I include minimum loan repayments under “needs”? Because if these minimum payments are not made, it will negatively affect your credit score. To maintain your credit score, you need to keep making the minimum payments.
Other things that people think they really need and are essential (i.e. streaming services, eating out, gym memberships, etc.) technically are not part of this category. That’s because while your physical fitness is important (and some may say essential) for overall health, you don’t need a $50/month gym membership to make it happen. Instead buy a $40 pair of gym shoes and go for a run.
A good rule of thumb is if there is a less expensive option available (i.e. cook yourself ilo eating out), it is a want.
30% Of Monthly Money for Wants
This section is also known as discretionary, personal, or non-essential spending. These are the things that you could technically live without. Wants are the nice things or little upgrades you spend money on that make life more fun and enjoyable.
Wants may include:
- Eating out
- Streaming Services
- Ultra-High-Speed Internet
- Gym Memberships
- Vacations
- Concerts
- Sporting Events
- Electronic Gadgets
- Hobbies
- Expensive clothes (big upgrade over the basics)
At its simplest, wants are optional. For example, you can work out at home ilo of going to the gym (I do! 😊), cook at home instead of eating out, use a lower speed internet service, or watch sports on TV vs going to the game.
20% of Monthly Money for Savings
This is what you save every month. It includes personal savings account, retirement, college for your kids, and even accelerated debt repayment. Extra debt payments may not seem like part of savings, but it is. Reason is the minimum debt payment is under “needs” because without making these payments your credit score suffers. Accelerated debt payments is part of savings because the money is being chosen to be spent on debt repayment instead of accruing in a savings account. “Savings” really means growing your net worth and there are 2 ways to do it: increase savings or reduce debt.
Saving this much of your income may sound like a lot but it really isn’t. For example, let’s assume you have a take home pay of $5,000 / month. This means that a $1000 a month goes towards your 401K, IRA’s, personal savings accounts, accelerated debt repayment, and 529 plans for kids.
Here is a monthly snapshot of what that could look like:
- $250 – 401K (5% of monthly after-tax salary)
- $250 – Personal Savings (5% of monthly after-tax salary)
- $250 – Roth IRA (5% of monthly after-tax salary)
- $250 – extra credit card payment (5% of monthly after-tax salary)
See what I mean? It doesn’t take much to get to 20% savings. Which leads me to my next point.
Why I Do Not Like The 50/30/20 Rule
I don’t like this rule because too much money is being spent on wants and not enough on savings.
Here is an example:
Let’s again assume that we have an after-tax income of $5,000 / month (~ $86,000 pre-tax annually).
Using the 50/30/20 rule, $2500 is spent on needs, $1500 per month is spent on wants, and $1000 is spent on savings.
Spending $2500 on needs falls in line with what I expect is required to live on.
Here is a sample breakdown:
Mortgage – $1200 ($170K at 3.5% on 30-yr fixed mortgage)
Utilities – $300
Food – $200
Car Payment – $400
Student Loans – $300
Min. Credit Card Payment – $100
Now here is a sample of spending $1500 monthly on wants:
Gym Membership – $50
Vacations – $300
Eating Out – $300
Entertainment – $400
High – Speed Internet – $50
Streaming Services – $100
Hobbies – $150
Latest Cell Phone – $50
Concert Tickets – $100
Lastly, here is a breakdown of savings we used above:
$250 – 401K (5% of monthly after-tax salary)
$250 – Personal Savings (5% of monthly after-tax salary)
$250 – Roth IRA (5% of monthly after-tax salary)
$250 – extra credit card payment (5% of monthly after-tax salary)
See anything wrong with this? I do
The 1st thing I see out of whack is how much this person is saving for retirement. Counting both the 401K and IRA savings, they are only saving 10% of their income. This isn’t enough. This person is only putting enough in to get the employer match plus a few bucks extra each month into a Roth IRA. A minimum of 15% with a preference of up to 25% should be saved for retirement.
The 2nd thing I see is that this person is really enjoying life! Now there is nothing wrong with enjoying the fruits of your labor, but it is coming at the expense of future financial security. Not a good tradeoff. This person is spending 1 ½ times more on near-term fun than on long-term retirement!
How I Would Modify The Rule
IMO and from my personal experience, people tend to think they have to save less than they really need to and spend more money than they really should. Adopting a “saver mentality” is one of the 1st things to do to achieve financial freedom. Now, I’m not talking about being frugal or a miser. I am talking about understanding what is really important to you and making promises to yourself to achieve what is important to you.
To do this, a higher priority needs to be placed on savings and debt repayment while placing a lower priority on wants.
Here is a proposal for a new rule to follow. I call it the 50/30/10/10 Rule:
- 50% – Needs. Includes all living expenses and minimal debt payments (i.e. car, mortgage, student loans, credit cards, food, gas, utilities, etc.).
- 30% – Savings (including 401K, emergency fund, personal savings, etc.)
- 10% – Accelerated Debt Payoff
- 10% – Wants / Vices
New Example
Here is an example:
Let’s again assume that we have an after-tax income of $5,000 / month (~ $86,000 pre-tax). Using the 50/30/10/10 rule, $2500 is spent on needs, $1500 per month is spent on savings, and $500 is spent on wants, and $500 is spent on accelerated debt payment.
Spending $2500 on needs falls in line with what I expect that is required to live on.
Here is a sample breakdown:
Mortgage – $1200 ($170K at 3.5% on 30-yr fixed mortgage)
Utilities – $300
Food – $200
Car Payment – $400
Student Loans – $300
Min. Credit Card Payment – $100
For savings, $1500 a month goes towards your 401K, IRA’s, personal savings accounts, and 529 plans for kids (if needed).
Here is a breakdown of savings:
- $750 – 401K (15% of monthly after-tax salary)
- $375 – Personal Savings (7.5% of monthly after-tax salary)
- $375 – Roth IRA (7.5% of monthly after-tax salary)
This is more in line with what I expect to see in pure savings. By breaking out accelerated debt payments into its own category, it is much easier to track how much your really are spending on pure savings.
By putting the priority on saving for the future, it allows your retirement account to use the time value of money and the magic of compound interest to grow your account more efficiently in the early years. Biting the bullet now to save for the future puts the money to work for you when less is needed to grow your retirement fund to large levels.
If you wait to save for retirement until your later years (after the age of 40), it will take saving A LOT more money to achieve the same goal.
Don’t believe me, use this tool or this tool, to plug in numbers to see how much you’ll need to save later in retirement to reach the same goal. It’s eye opening!
Now here is a sample of what spending $500 monthly on wants now looks like:
- Gym Membership – $10 (Planet Fitness! 😊)
- Vacations – $150
- Eating Out – $100
- Entertainment – $100
- Streaming Services – $40
- Hobbies – $50
- Concert Tickets – $50
You can still enjoy yourself and I dare say have even more fun while spending less. The key is to be creative with your resources and enjoy the great things in life that cost very little. For example, instead on spending top dollar for that all-inclusive Caribbean resort, try taking a road trip to visit a friend who lives across the country. A great way to build lasting memories and save a ton of money in the process.
Instead of eating out so much, buy a cookbook and learn to make the dishes you really love. My rule of thumb is that I only eat out for things I either do not know how or am not good at cooking at home.
For example, I make a mean hamburger and cannot remember that last time I ordered a takeout burger. On the other hand, I do not know how to cook Thai food (and I LOVE Thai food! Yum! 😊) so I spend the money to go eat out. Like Surf ‘n’ Turf? Learn to make it at home. The bonus is you get to make it the way YOU want, and it usually tastes just as good as any restaurant.
Lastly, entertainment can be just as enjoyable without spending so much money on it. A lot of cities now have a free concert series where you can go and listen to good music for free. Enjoy going clubbing? Have your friends come over to pre-party, bring their favorite drink of choice to share, call a Lyft, and go have a great time! You’ll spend less, enjoy it just as much, and get home safe. It’s a win-win!
Lastly, here is a breakdown of spending $500 on monthly accelerated payments:
- $250 – extra student loan repayment (5% of monthly after-tax salary)
- $250 – extra credit card payment (5% of monthly after-tax salary)
Spending a little extra each month on accelerated debt payments does 3 things. First, making additional payments save a ton of interest in the long run. Second, making extra payments makes you feel good about yourself! It feels great knowing that you don’t have such a big burden over your head. Lastly, once that debt is retired, it will be your choice how you spend this extra money!
You could increase your “wants” budget. You could accelerate retirement savings. Hell, you could next save for a down payment on a vacation home or rental property. The choices are endless!…. and is just that, choices. Choices on how to spend your money and the freedom to choose what you do with it. Sounds great doesn’t it? 😊
Doing it this way also builds in a margin of safety. Let’s say, due to COVID, your employer is losing business and tells everyone they must temporarily take a 10% pay cut. No problem! Just temporarily quit making extra debt payments. As my girls say, “easy peezy” lol 😊
What To Do From Here
If you’re struggling to budget your money and not sure what to do, using one of the rules we described is a great way to get started. It’s easy, simple, and fairly intuitive.
Budgeting doesn’t need to be overly complicated, and it shouldn’t take hours to implement. The rule gives a simple, clear, big-picture view of your monthly budget that can help you avoid overspending and keep your goals on track without having to painstakingly record every single transaction.
Lastly, remember that the “rule” is really a guideline because any budget needs to be adjusted for a person’s particular goals. There is no such thing as a one-size-fits-all approach since each person has unique financial goals.
The important thing is to get started and just do it. You got this!
Live The Life You Love, Want, and Deserve!