Simplify your budget with the 50/30/20 rule
If you struggle making sense of a sea of budgeting systems and apps, consider the 50/30/20 rule. Developed by Elizabeth Warren, a U.S. Senator from Massachusetts, the 50/30/20 rule states that your after-tax income should be roughly divided three budget categories:
- 50% to needs
- 30% to wants
- 20% to long-term savings
The 50/30/20 rule is only a guideline. The beauty of the rule is its simplicity. Sophisticated budgeting systems are complicated and stressful. Budgeting is something you must do your entire life. Finding a way to simplify it can have huge impacts on your financial future.
50/30/20 Rule Categories
Needs – 50%
People define their needs in vastly different ways, but there are several things everyone can agree on: housing, food, utilities, and transportation—to name a few. Another necessity that may not jump to mind as quickly is insurance. Whether it’s life, auto, homeowners, or health, insurance is absolutely vital to protecting you, your loved ones, and your property.
Examples of needs:
- Housing: Rent, mortgage, homeowners insurance, property taxes
- Transportation: Car payment, gas, bus or train passes, parking fees
- Insurance: Auto, life, homeowners, health, renters
- Utilities: Gas, water, electricity, internet, cell phone
- Loan payments: Credit card debt, student loans
- Short- to mid-term savings goals: Down payment on a car, a new roof, replacement furnace
- Health care: Insurance premiums, deductibles, prescriptions
Note that there are two kinds of necessities, routine expenses and predictable goals. Some things you’ll pay for regularly and others require you to think ahead and anticipate future needs.
Wants – 30%
While the necessities are easy to agree on, wants are subjective and personal. A vacation you consider valuable —essential, even—your partner might find frivolous and wasteful. The 50/30/20 rule encourages you to be explicit about your wants. But don't beat yourself up over them. Give yourself permission—within a reasonable set of constraints—to spend some of your money on things that make your life enjoyable.
Examples of wants:
- Gym memberships
- Online subscriptions
- Cable TV
- Eating out
Chances are you’ll see similarities between your wants and needs. Clothing, for example, is a necessity, but you can shop for bargains or consignment businesses to save money to put toward items on your needs list. Ultimately, it’s about balancing your wants and needs.
Savings – 20%
There is no financial habit as important as saving. Unsurprisingly, it's also the hardest. Saving a little each paycheck can make things much easier when unexpected expenses come up. Whether you follow the 50/30/20 rule or not, you should make a goal to save a significant portion of your income for rainy days and retirement.
Set aside a portion of your income each month in a savings account to create an emergency fund. A savings account will psychologically earmark your money, making it less likely you'll withdraw it for spontaneous reasons. While your rainy day fund may require a little sacrifice now, it can be lifesaving if you're laid off from work or met with a sudden medical emergency. If disaster strikes, you can easily transfer the funds to a checking account to get you through.
One of the great secrets to saving is finding ways to make it automatic. Don't put yourself in the position of deciding how much to save with each paycheck. Make the savings decision once and keep that going as long as possible.
Saving isn’t only about securing your financial future, it instills confidence and self-respect. You can make saving less nebulous by giving your savings a purpose. Do you want to buy a home? A new car? Go on a dream vacation? Save for that purpose. This will give you a reason to save, rather than just doing it because you feel like you should.
Make Adjustments to your budget
Like all budgeting methods, the 50/30/20 rule is not perfect, and shouldn't be applied as defined to every budget. Saving 20% is a large number for some people to achieve. If saving 20% feels like too much for you, start with a 60/30/10 rule and adjust as your needs and income change. If you're a high-income earner, consider saving (and investing) more than 20%, especially if you intend to travel. No matter your financial circumstances, resist the temptation to compare yourself to others. Make adjustments. Place an emphasis on your long-term goals.
Start budgeting today
The best time to start budgeting and take the first step in managing your finances is now. The advantage of the 50/30/20 rule is it’s simplicity. No complex formulas or charts just three key areas that you can use to manage your money and your savings.