Dissecting The 50-30-20 Budgeting Rule

What is the 50-30-20 Rule?

The 50-30-20 Rule is currently the most popular budgeting method around. It’s the go-to allocation breakdown you would generally get if you were to get personal finance advice. In a very quick TL;DR sense: the 50-30-20 Rule splits your income into three different categories – needs, wants, and savings + debt. However, it is important to note that the number you will be working with is after-tax income and to remove any other payroll deductions from this number such as your 401(k), health insurance, and any other payments that have been automated.

50% of your income will be allocated for needs. This means that 50% of your income will be going towards expenses that are seen as necessities. These would include:

• Housing
• Utilities
• Food
• Transportation
• Insurance
• Minimum loan payments

If your spending in this category is above half your after tax income, you might want to dig a little deeper into what you can avoid or downsize. This can be in the form of buying the off brand grocery items, cutting your own produce vs. pre cut produce, look for smaller housing, making sure that lights and appliances are off when you’re not using them, drive a modest car, or decide to carpool with co-workers or take public transportation.

30% of your income will go towards your wants. The difference between your needs and your wants are that your needs are seen as things you can not survive without. On the other hand, your wants could be described as things that aren’t essential to your day to day survival. Generally wants are things that make your life more fun. These would include:

• Entertainment
• Clothes
• Eating out
• Date nights
• Gym memberships
• Traveling
• Monthly subscription plans
• Premium plans

The spending in this portion of your budget can get out of hand if you do not watch it closely enough. In the case that this category goes over or if you find yourself hitting 30% much quicker, consider going for items and services that are one tier lower than the ones you are currently picking. If you’re getting the large consider getting the medium instead. If you’re going for the filet mignon or ribeye consider the sirloin. Alternatively, cut back on the days you decide to go out.

20% of your income should be going towards your savings and debts. Savings is an important aspect of your financial health since it can help you for any unforeseeable situations that might come up. It’s also important to start saving for retirement early on in order to take advantage of compounding interest. On the same side of the coin, tackling debt as quick as you can is beneficial so you don’t rack up large amounts of interest for your loans. These would include:

• Saving for a emergency fund
• Saving for your retirement through either a Roth IRA, Traditional IRA, or 401(k).
• Paying off your debt to make sure that your accumulated interest does not get out of hand

Financial professionals often say that you should have at least three to six months in your emergency savings account in case a unforeseen circumstance occurs. After this milestone has been reached, focus towards other financial milestones such as your retirement fund, brokerage account, car, house, vacation, or anything else that requires a large sum of money.

Though this 20% section of the budgeting plan includes debts, similar to the 50% section, this section focuses on extra payments which would eventually lower your total accumulated interest throughout the lifespan of any loans, therefore “saving” you money.

A step by step guide for applying the 50-30-20 Rule

1. Figure out how much you’re actually taking home by calculating your after-tax income. This might be a little more tricky if you are working as a freelancer, but generally it should be what you earn per paycheck minus your business expenses and the amount you’ve put aside for taxes. If you’re an employee of a company, this should be easier to do. Assuming that you have enrolled into tax withholds and pre-tax deductions, such as insurance and retirement accounts, the check or direct deposit number should be the number you are working with.
2. Categorize all of your expenses into three different sections: needs, wants, and savings + debt. Remember that your needs are the essential expenses for you to survive on a day to day basis. Your wants could be more luxury items and expenses. Savings are allocations of money that are meant to help you prepare for the future, either that be in a form of a retirement account or for a rainy day emergency fund. Debts are previous loans you have taken out in order to pay for a product or service: that could be student loans, mortgage payments, credit card debt, and car payments.
3. Analyze your allocation of money and adjust it to fit the 50-30-20 Rule. Usually you would have one fixed cost, which is the allocation you put towards your needs. Though this percentage can change according to your job status (pay rise, job change, etc), you will primarily be focused on your wants and savings + debt. If the percentages for these two are lower or higher than 30% and 20% respectively, see what you can cut back on, or ideally, how to maximize these two portions.

Alternatives to the 50-30-20 Rule

It’s also important to note that even though the 50-30-20 Rule is generally the most well known budgeting allocation, there are other budgeting methodologies out there. This rule was originally created in 2005 by Elizabeth Warren and Amelia Warren Tyagi in their book “All Your Worth: The Ultimate Lifetime Money Plan.” As of writing this article, this rule is 17 years old and only accounted for the average person. If this does not work for you, consider allocating your income into different percentages depending on your own personal situation, such as 20-40-40 or 70-20-10. Or even try other budgeting methods that will be more suited to your own specific needs.