50/30/20 Rule: Basic Budgeting Gets a Makeover
When you’re engrossed in the process of budgeting, the last thing that you want to do is think about even more numbers. After all, there is nothing like a day of crunching digits to make our heads dizzy.
However, no matter where you are in your financial journey, it’s important that you know about the 50/30/20 rule. Although it has gained popularity in recent years, there are still many misconceptions floating around about this popular financial ethos.
In this article, we’ll realistically look at this buzzworthy concept and discover the origin of the 50/30/20 rule, how to use it, and the pros and cons of applying this philosophy to your finances.
What is the 50/30/20 Rule?
First thing first: what is this so-called 50/30/20 rule? At its core, it simply means allocating your after-tax income in the following ways: 50% to essential expenses, 30% to wants, and 20% to savings and debt payments.
1. 50% of Your Income is Spent on Essential Expenses
Under the 50/30/20 rule, half of your after-tax income can go to essential expenses. These can include:
- Rent or mortgage payments
- Utilities and other bills (hydro, gas, internet, cell phone, etc.)
- Transportation (public transit, car payments, gas, insurance, etc.)
- Medical and dental expenses
- Grocery bills and other food costs
- Minimum payments on all debt (minimum only — we’ll explain why later)
It may be confusing to hear if you’ve heard again and again that your rent or mortgage payment should constitute no more than 30% of your income.
While this remains good advice, much to the relief of those of us who live in cities with a high cost of living, the 50/30/30 rule takes a bit more of a realistic approach by stating that your essential living expenses should be no more than half of your income.
Please note, though, that this includes your utility bills, groceries, internet bills, phone bills, and anything essential to your everyday life.
You should also note that this part of the budget includes your minimum debt payments, an essential expense as missing these payments could cause repercussions.
2. 30% of your income is spent on wants
Under the 50/30/20 rule, 30% of your income can go to things you do not need, but want. These expenses can include:
- Subscription services (Netflix, Spotify, Disney+ etc.)
- Live concerts and other entertainment
- Meals at restaurants and take-out
- Leisurely travel
- Leisurely shopping
3. 20% of your income is spent on savings and debt
Under the 50/30/20 rule, spending 20% of your income on savings and debt can include:
- Paying off credit cards
- Paying off lines of credit
- Paying off student or car loans
- Contributing to your emergency fund
- Contributing to retirement savings, such as your 401k in the United States or your Registered Retirement Savings Plan (RRSP) in Canada
While fair and feasible, the 50/30/20 rule does not forget about the importance of paying down debt and adding to a savings account.
Under this plan, 20% of your income should go towards paying down accounts owing and adding to a savings bucket, whether it be your emergency fund or a savings goal.
Note that these payments are beyond your minimum payments, which come out of your first bucket.
How Does the 50/30/20 Rule Work?
If this budget looks good to you on paper, you may be wondering how to apply it to your life.
Thankfully, the 50/30/20 is as easy to implement as it is to understand. What's better is that when implemented correctly, the 50/30/20 can help you save money, pay off debt, and have fun.
Here are some simple steps to help you use the 50/30/20 budget towards your unique financial goals:
- Take a look at your income: It's important to note down not what your pre-tax income is but your post-tax (i.e. take-home) income.
- Make a note of your immediate needs: ensuring that they add up to 50% of your income. If you find yourself overspending, it might be a good opportunity to look at the areas in your life that you can cut back on, if possible. You may have to compensate by cutting back on your income's next portion, which means your wants.
- Make a list of all of your wants: Try limiting yourself to a total of 30% of your overall budget.
- Make a list of your long term saving goals: 20% of your budget will be designated for this, whether it be putting money into a savings account with a high-interest rate or putting money into a retirement account.
- Hold yourself accountable!: It's okay if sticking to your budget feels harder on some months than others, but consistency is also important.
50/30/20 Rule Pros & Cons
Pros: The Good Stuff
Flexibility works well for fluctuating income
Allocating 20% of your budget to saving can help with long term goals
Can effectively pay down debt quickly
Cons: The Not So Good Stuff
Impractical for those on very strict incomes who may not have as much room for “wants”
May not be the best option for those who are looking to pay down high-interest debt as quickly as possible
Frequently Asked Questions
As a matter of fact, yes. Senator Elizabeth Warren coined this budget’s term and created the concept in her 2006 book “All Your Worth: the Ultimate Lifetime Money Plan”.
It certainly holds that potential. If you are able to stick to a 50/30/20 budget, 20% is a considerable amount of your income to put towards savings. It will, of course, depend on the amount of debt you carry as well as the nature of your post-tax income.
The three categories of the 50/30/20 budget are as follows: essentials, wants, and savings.