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What Is the 50/30/20 Rule?

The world of personal finance can feel complicated. But don’t let the complexity prevent you from hitting your goals! There are simple budgeting techniques that you can use today that will revolutionize your current financial situation. One of those budgeting techniques is the 50/30/20 rule. 

Never heard of the 50/30/20 rule? That’s okay. We’ll cover everything you need to know from A-Z. 

What is the 50/30/20 rule of thumb? Simply put, this rule of thumb allows you to spend your money into three different categories. Each category gets a predetermined amount of your overall net income. These buckets are: 

  • 50% of your money is spent on needs
  • 30% of your money is spent on wants
  • 20% of your money is reserved for savings 

How To Use the 50/30/20 Rule

The concept of the 50/30/20 rule isn’t challenging, but keeping everything in proportion may take a bit of adjusting to. 

50% of Your Income: Needs

As mentioned above, 50% of your income is reserved for your needs. The following expenses are common needs: mortgage or rent payments, the electric, heat, and water bills, gas for your vehicle, health and vehicle insurance, and groceries. 

30% of Your Income: Wants

Dedicating 30% of your income to your wants is where many people struggle. It’s difficult to say no to something you want, or to postpone that purchase until a later date.

A want can be: an article of clothing you like but don’t need, eating out, subscription entertainment memberships, entertainment, traveling, and even transportation (if you have a good car now, upgrading to a newer model isn’t needed!). 

20% of Your Income: Savings and Debt

Once you’ve balanced the above, spending 50% of your income on needs and 30% of your income on wants, the remaining 20% should be used to either pay off debt or the money should be saved. 

Paying off debt helps you save money in the long term. Debt comes in all shapes and sizes, and also various interest rates. Having $5,000 in credit card debt at a 20% interest rate will make saving money significantly more challenging. Paying off debt before saving money is a strategy that serves many people well. 

If all your debt is paid off, you can save all of that money! Saving money has numerous benefits, including the flexibility cash reserves provide and the ability to invest your money elsewhere to earn a return. 

Example of the 50/30/20 Rule in Practice

John Smith’s take home pay (net pay after taxes) is $50,000/year. Under the 50/30/20 rule, John would dedicate $25,000 to his needs, $15,000 to his wants, and $10,000 to paying off debt or savings accounts. 

Keep in mind, everyone’s mix may vary slightly. You can take a long hard look at all your ‘needs’ in life, and that may only add up to 40%. If that’s the case, you can save more or pay off debt! 

Is the 50/30/20 Rule Budget Good for You?

The 50/30/20 rule has gained popularity in the personal finance world because it takes something rather complex as developing a budget and simplifies it. Again, the concept of this budgeting rule is simple, but being sure to not step out of bounds is where it becomes challenging.

Many of us have a spending problem on wants. Going out to eat, driving a new car, and traveling are all great experiences. By no means is the 50/30/20 rule suggesting you can’t do any of those fun things, but it puts some parameters in place. 

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

This rule stems from a fantastic personal finance book, All Your Worth: The Ultimate Lifetime Money Plan, written by Elizabeth Warren. Even though the book was published in 2005, this rule started to gain more traction in 2008 due to the housing crisis. 

50/30/20 Rule of Thumb vs. Other Common Budgeting Methods

A good personal finance plan is like a good diet… it only works if you stick to it. Finding a financial plan that you can stick to is a critical piece to ensuring your financial success. Without question, the 50/30/20 rule is a powerful and impactful tool, but it’s not the only option. 

Line Item Budget

A line item budget is similar to the 50/30/20 rule of thumb in a sense that a specific amount of money is allocated to specific categories. However, unlike the 50/30/20 concept, there are more than 3 categories.

For example, the “wants” category may be broken out into the following line items; travel, eating out, subscription memberships, clothing, and giving. Each line item will have its own budgeted amount and the category as a whole will not be given a 30% limit. 

For a line item budget to be accurate, you must look at historical data. For example, if you keep accurate records of where you spent money for the prior year, totaling up everything accordingly and bucketing those expenses into the various line items would be a great starting point. You’ll identify where you’re overspending and can build your new budget with more strict parameters. 

Pay Yourself First

Paying yourself first is exactly what it sounds like. Before you pay any of your bills, including your needs/wants, you need to take a certain percent of your income and put it in a savings account. Finding out that percentage is key, some folks aim for 20% whereas others are able to allocate 10% to savings. 

The easiest way to carry this forward is to have a portion of your paycheck automatically deposited into a separate savings account. Therefore the money is out of sight and out of mind, and you can’t spend it via your debit card! 

Zero-Based Budgeting

The goal behind zero-based budgeting is to have your income minus your expenses equal to zero by the end of each month. This concept gives a purpose to every dollar you make. 

In practice, this budgeting technique is rather time consuming. You need to forecast future expenses and predetermine how you’ll allocate your money accordingly. Any dollar that isn’t being used for an expense is saved. The biggest advantage of a zero based budget is the visibility it provides on your inflows vs. outflows. The more aware you are of where/how you’re spending money, the more likely you are to make better financial decisions.

Incremental Budgeting

If you already have a good budget in place and it’s working for you, there may not be a need to make dramatic changes. Instead, you can make incremental changes along the way. Look at where you spent money in the previous quarter or year, and identify areas where you’d like to improve those spending patterns. 

Perhaps you didn’t pay off as much debt as you would have liked to, or you spent too much money eating out. Developing some parameters around the categories will help you save more money. Incremental changes can make a world of difference. 

Value Proposition Budgeting

Value proposition budgeting is more common in the business field. This concept is more of a mindset shift, where all expenses or investments are designed to deliver value to the organization. In the world of personal finance, it can be a very binary way of looking at your finances. The question to ask yourself before spending a dollar is, ‘does this expense align with my goals?’ if no, don’t spend it, or think twice before doing so! 

The nuance here is that some expenses still need to be done. For example, you still need a roof over your head and food on the table. Also, life is about enjoying various experiences. All of these experiences may not align with your financial goals, but are still worth doing. 

Envelope Budgeting

Envelope budgeting is a great tool if you prefer to spend cash. This budgeting concept takes your income and divides it into various envelopes each month. You put cash into the envelope, and that’s the money you can spend for each category per month.

This budgeting concept stays true to the needs, wants, savings/debt repayment approach. However, the wants are bifurcated into various subcategories. Each sub category will have a specific amount of money allocated to it – similar to the line item budgeting concept. 

You’re free to spend all the money in a given envelope. In the event you don’t, that money can be rolled forward to the next month. For instance, if you’re “eating-out envelope” is $200 a month, and you only spend $125, the balance of $75 is either rolled forward, or allocated to the saving envelope. 

Budgeting Made Simple 

The COVID-19 pandemic was a reminder of how important it is to save money. Saving money should never be a goal, it’s an absolute necessity. The 50/30/20 budgeting is a powerful personal finance tool that will help you manage and save your money. 

Under this ruleset, 50% of your money can be spent on needs, 30% of your money is spent on wants, and 20% of your money is spent on either repaying debt or saving. 

Saving money is only one piece to the personal finance pie. Capital preservation and appreciation are other important objectives. Working with a financial advisor is a great way to ensure all your bases are covered. A financial advisor will not only help identify any bloat in your spending habits, they’ll also help you find investments that are aligned with your goals and risk tolerance.