The 50-30-20 rule makes budgeting as simple as dividing your paycheck into 3 categories. Many families like the 50-30-20 rule because it provides a clear structure and specific goals without feeling nit-picky. Anyone can implement the 50-30-20 rule in 4 easy steps.
The 50-30-20 rule allocates all of your income into 1 of 3 categories: needs, wants, and savings. The first 50% of your income pays for your needs. The next 30% of your income supports spending on wants. The last 20% builds your savings.
“Needs” include any expense necessary to support a healthy life. These costs go towards the things you need day-to-day. In this category, most families include groceries, housing, utilities, health insurance, and transportation.
“Wants” include the little extras that we enjoy but could live without. This category does not give you license to spend freely on extravagances, but everyone deserves to treat themselves from time to time. Think of shopping for new clothes, buying the latest electronics, travel, dining out, and hobbies.
The “savings” category includes retirement money, emergency funds, and outstanding debt. You can think of retirement funds as an investment in your future “needs” and “wants,” after you retire. Emergency funds support you when all other accounts cannot. The 50-30-20 rule puts debt into the “savings” group because debt decreases your net worth just as savings increase your net worth. This is especially true of high-interest debts like credit cards or personal loans that you might want to pay off before putting your money to work elsewhere.
Estimate your after-tax income in a typical month. You may not earn a regular paycheck, but try to estimate an accurate figure. You can look at your bank statements for the last 3 months to get a general idea if needed. If you have a salary, divide your annual income by 12 months to get 1 month's worth of pay. Then subtract your taxes from that monthly amount.
For example, if you earn $60,000 in a year before taxes, then you can divide $60,000 by 12 months to know that you earn $5,000 in monthly before-tax income. If you expect to be taxed at ~25% of your income, then you can subtract 25% of $5,000, or $1,250 in taxes, to see your after-tax monthly income as $3,750.
Time to budget for your “needs” category. You cannot live healthily without spending on groceries, housing, health insurance, and transportation. That said, you can reduce how much you spend on purchases in each of these areas. Do yourself a favor and take public transportation if you can. Take better care of clothing to make it last longer. Choose modest home furnishings or choose to shop when stores hold sales for big-ticket items. In total, do not spend more than 50% of your after-tax income on your needs. Following our example above, a family earning $3,750 per month after taxes would limit spending on their needs to $1,875 each month.
When you budget for “wants,” you budget for all the niceties of daily life. Living comfortably does not mean living lavishly or extravagantly. Think more along the lines of unlimited data and texting plans, subscriptions to Netflix and Spotify, or a yoga class; not luxury vacations, weekly dinners at 3-star restaurants, or jewelry. We know temptation happens, but financial fitness, like physical fitness, requires some dedication and self-control. Following the example, a family earning $3,750 per month after taxes would limit spending on their wants to $1,125.
Saving 20% of your after-tax income keeps you on a solid financial footing. This category strengthens your emergency fund buffer, builds your retirement accounts, and pays back the money you owe. Continuing with our example, a family earning $3,750 per month after taxes would have $750 remaining for savings and debt payments.
Remember, you borrow money every time you swipe your credit card or take out a loan. Until you repay it, the burden of your debt reduces your overall net worth. For many, it makes more sense to pay down debt, especially high-interest debt, before putting this 20% to work in savings.
Some debts do fall into your “needs” category, like car loans and mortgages. You cannot live a healthy life without a roof over your head and it may be impossible to earn a solid paycheck without the proper transportation for work.
Putting our example all together, an example plan might look like the following.
$60,000 annual before-tax income
$5,000 monthly before-tax income
25% tax rate = $1,250 owed in taxes
$3,750 after-tax income
$3,750 after-tax income
$1,875 for “needs”
$1,125 for “wants”
$750 for “savings”
The 50-30-20 rule might not be right for everyone. The effectiveness of the tool depends on your situation. Having only 3 categories to track might appeal to those trying to streamline or those looking for simplicity. For others, the 50-30-20 rule might lack much-needed structure.
The 50% allocation for your needs could be another drawback depending on your personal circumstances. Some people live in areas where the cost of their needs exceeds 50% of after-tax income. For instance, some families may need to allocate meaningfully more income toward housing and transportation in cities with very high costs of living. This could make it nearly impossible to cover all of their needs with only 50% of after-tax income.
The 50-30-20 rule might also present drawbacks for high-income earners. Some experts feel that the simple 3-category approach focuses too much on balancing spending and debt management. For high-income families, experts might recommend budget tools with greater emphasis on savings or investment options.
The 50-30-20 rule works well for families that do not want to micromanage their finances. By focusing on 3 simple categories, this budget tool makes it easy for anyone to manage their spending and start saving. 50-30-20 budgeting might not be the best option for everyone, but starting any kind of budget is much better than not budgeting at all. The 50-30-20 budget rule is a good place to start. Keep in mind that you can always adjust it to best fit your circumstance.
Reading is the easy part. Things get hard when you start to apply what you learn. Growing your savings takes time, building smarter spending habits requires effort, and keeping tabs on it all can feel tedious.
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