What Is the 50/30/20 Rule?
The 50-30-20 rule encompasses the division of your revenue into three categories of spending: 50% goes to needs, 30% goes to wants, and 20% goes to savings. Note that the revenue referred to in this case is the income after all taxes and deductions have been made, therefore can be referred to as the net income. This intuitive and straightforward rule can help you draw up a reasonable budget that you can stick to over time to meet your financial goals.
Needs are the bills that you absolutely must pay and things that are necessary for survival. Half your after-tax income should be all you need to cover those needs and obligations.
50%: Needs
Consider either cutting down on wants or trying to downsize your lifestyle if you’re spending more than 50% on your needs. This might mean downsizing to a smaller home or a more modest car. Maybe carpooling to work or cooking at home more are solutions. Examples of needs include but aren’t limited to:
- Rent or mortgage payments
- Car payments
- Groceries
- Insurance and health care
- Minimum debt payments
- Utilities
30%: Wants
Wants are the things you spend money on that aren’t absolutely essential. You can work out at home instead of going to the gym or watching sports on TV instead of getting tickets to the game.
This category also includes those upgrade decisions you make such as choosing a costlier steak instead of a less expensive hamburger, buying a Mercedes instead of a more economical Honda, or choosing between watching television using an antenna for free or spending money to watch cable TV. Wants are all those extras you spend money on that make life more enjoyable and entertaining. Examples of wants include but aren’t limited to:
- Unnecessary clothing or accessories like handbags or jewelry
- Tickets to sporting events
- Vacations or other non-essential travel
- The latest electronic gadget, especially an upgrade over the fully functioning model you already have
- Ultra-high-speed internet beyond your streaming needs
20%: Savings
Try to allocate 20% of your net income to savings and investments. You should have at least three months of emergency savings on hand in case you lose your job or an unforeseen event occurs.2 Focus on retirement and meeting more distant financial goals after that. Examples of savings can include:
- Creating an emergency fund
- Making contributions to a mutual fund account
- Setting aside funds to buy physical property for long-term holding
- Making debt repayments beyond minimum payments1
The first allocation of additional income should be to replenish your emergency fund account if any of these funds are ever used.
Importance of Savings
Most people are notoriously bad at saving thus leading to high levels of debt.
The 50-30-20 rule is intended to help individuals manage their after-tax income, primarily so they have funds on hand for emergencies and savings for retirement. Every household should prioritize creating an emergency fund in case of job loss, unexpected medical expenses, or any other unforeseen monetary cost. A household should focus first on replenishing their emergency fund if it’s used.
Saving for retirement is also a critical step because individuals are living longer. Calculating how much you think you’ll need for retirement at a young age and then working toward that goal can help ensure a comfortable retirement.
Benefits of the 50-30-20 Budget Rule
The 50-30-20 rule can guide individuals to financial prosperity in several ways. Potential advantages of these guidelines include:
- Ease of use: The 50-30-20 rule offers a straightforward framework for budgeting. It’s simple to comprehend and apply. You can distribute your income immediately without the need for intricate calculations. Even the least financially savvy individual can adhere to these rules.
- Better money management: You can manage your money in a balanced way by using a budget. You can ensure that your necessary costs are covered, that you have money for discretionary spending, and that you’re actively saving for the future. You can save for current as well as future needs this way and still have a little fun with your finances.
- Prioritization of vital expenses: You can make sure you cover your fundamental needs without going over budget or taking on too much debt by giving these basics top priority. These rules stipulate that half of your budget goes towards needs so this plan helps make sure your essentials are more likely to be met.
- Emphasis on savings goals: You can set up an emergency fund, prepare for retirement, pay off debt, invest, or pursue other financial goals by allocating 20% of your income to savings. You’ll establish sound financial practices and build a safety net for unforeseen costs or future goals by consistently saving this amount.
- Long-term financial security: You can prioritize your financial future by continuously setting aside 20% of your salary. This expenditure to savings can help you accumulate money, meet long-term financial objectives, and give yourself and your family a sense of security in either the short or long term.
The idea behind the 50-30-20 rule is that anyone can use these proportions regardless of their income. You may have to adjust the percentages, however, if your income is low or you live in an area with a high cost of living.
The Bottom Line
Saving is difficult and life often throws unexpected expenses at us. The 50-30-20 rule provides individuals with a plan for how to manage their after-tax income. They can find ways to reduce expenses and direct funds to more important areas such as emergency money and retirement if they find that their expenditures on wants are more than 30%.
Life should be enjoyed and living like a Spartan isn’t recommended but having a plan and sticking to it will allow you to cover your expenses and save for retirement while enjoying the activities that make you happy.