Have you tried different budgeting strategies, yet to find one that fits what you're looking for? Consider the 50/30/20 budget method. The strategy implies that you should allocate 50%, 30%, and 20% of your money to three important categories of spending. Doing so will cover all of the major areas of finance to ensure your financial future is prosperous.
What is the 50/30/20 budget rule and how does it work? I've laid out a quick breakdown of how to implement it in your budget.
How The 50/30/20 Rule Works
Senator Elizabeth Warren first mentioned the 50/30/20 budgeting method in her popular book “All Your Worth: The Ultimate Lifetime Money Plan” – an exciting financial/self-help book and a must-read to add to your bookshelf.
Since its publication date in 2005, the strategy has become an industry norm followed by millions. Here's how it works.
First, Calculate Your Income After Taxes
The first step to implementing this plan is to calculate your after-tax income. If you're paid a salary, simply identify the tax bracket you are in based on your income, subtract your taxes, and you're leftover with your after-tax income.
An easier and quicker way to get to this number is to look at your last few pay stubs and take the average take-home pay after taxes are deducted each period.
Why use your after-tax income? Taxes are an expense that will always be there, and there is no use budgeting on your before-tax income if you are required to pay taxes no matter what. It's getting rid of an expense we'd otherwise have to include in our budget upfront, making things easier for everyone.
Next, Allocate 50% To Needs
Once you've determined your after-tax income, set aside 50% of that income to pay for necessary living expenses. This does not include expenses for luxury items like Netflix subscriptions or your daily gas drink on the way to work.
This money is used for things that you CANNOT live without such as:
- Hygiene products
- Debt payments
- Cell phone plan
Ok, some might consider a cell phone to be a want. I'd argue that it's a necessity in today's day and age – you be the judge! Regardless, the idea is only to include things that you need to maintain your most basic lifestyle.
Then, Set Aside 30% For Wants
The next step is setting aside 30% of your after-tax income to the “wants” category. This category includes things that you can live without but would be nice to have. Here you might include things such as your Netflix subscription and your daily morning gas station visit for that beloved monster energy drink.
Other items included in this category might be:
- New clothing
- Retail accessories
- Subscription services
- Date nights
If it's something you can live without but would like to have, then it's categorized as a “want” and not a “need.”
Finally, Contribute 20% To Savings
We can't forget about savings! If you're not keeping more money than you are spending, then you'll ALWAYS be broke! Allocating 20% of your after-tax income to savings is a sure way to prepare for an emergency and unexpected life events. Examples include:
- Job loss
- Car accident
- Unexpected health accidents
The idea is to be well prepared for any emergency that may surprise you, costing you an arm and a leg. Without a proper emergency fund in place, an accident can take literally break you financially.
A good rule of thumb is to save 3 – 6 months of living expenses for your emergency savings. This money should be saved in a basic savings account and not tied up in any type of investment.
Savings outside of your 3 – 6 month emergency savings should be properly invested for long term wealth building. I recommend that you start investing in the stock market!
Consider making retirement contributions to your employer-sponsored retirement account like a 401k. If your employer does not offer this, then you might want to contribute to a Roth IRA or Traditional IRA to start.
Benefits Of The 50/30/20 Rule of Thumb
Why would you use this rule in place of any other budget method out there? The short answer is that it's simple, it works, and it's easy to understand. When it comes to personal finance, simplicity is key to managing stress and staying on track.
By using the 50/30/20 budgeting method, you can be sure that:
- You live below your means – a requirement for building long term wealth
- You don't overspend on items that are not essential
- You're saving money each month for emergencies and long term wealth building
- Your regular budget review and updates will be quick, easy, and straight forward
- You will likely see an increase in your credit scores as you manage your spending categories
The great thing about this rule is that it will work with almost any other budgeting strategy, software, or app available today. It may even complement other budgeting resources.
50/30/20 Rule Example
Alex – a single, 35-year-old customer service representative for a tech company – makes a gross annual income of about $60,000. He is paid every two weeks, and his average paycheck after taxes is approximately $1,900.
Note: I used a helpful “paycheck calculator” from BankRate.com to get an estimate on after-tax income.
Because he is paid every two weeks, he has created a budget for a two week period, to be reviewed and updated each time he gets paid.
Alex uses the 50/30/20 budgeting rule because it's easy to follow and easy to calculate. Based on this rule, he calculates that his paycheck will be allocated as follows:
- Needs (50%): $1,900 x 0.5 = $950
- Wants (30%): $1,900 x 0.3 = $570
- Savings (20%): $1900 x 0.2 = $380
He will have $950 to pay for his necessary living expenses, $570 to pay for his wants and luxury expenses, and $380 will be put into his savings account. Remember, Alex gets paid every two weeks, so he updates his budget every paycheck.
Stated in annual income, Alex will have $24,700 per year to pay for his needs, $14,820 per year to pay for his wants, and $9,880 per year will go towards savings.
Because he is a salaried employee, his paycheck will be the same every two weeks and easy to update. If he was paid hourly, his paycheck might slightly vary depending on the exact hours he worked, but it shouldn't vary too much.
Tips For Using The 50/30/20 Rule
To make using this rule easier, you might consider opening up a separate bank account for each category. This will help you monitor your spending habits for each category.
Furthermore, it will help you better keep track of recurring expenses or payments like paying off debt, credit card payments, car payments, health insurance, etc.
Some have a hard time managing their urges to spend when their savings account gets fat. An easy way to eliminate the urge to spend your savings is to have your savings account at a separate bank than your checking account, eliminating the ease of transferring money for impulse purchases.
Should The 50/30/20 Rule Apply To Every Budget?
Budgets are different for everyone because there are so many variables to be considered, such as whether you're paid a salary, hourly, or straight commission.
You might have a high amount of debt and can't afford to allocate that amount to wants and savings. So, you may take a different approach. Perhaps you have an above-average salary and can afford to put a lot more money towards savings and wants, or you don't want to allocate as much as 50% towards needs – you be the judge!
Regardless of your scenario, the 50/30/20 budget rule of thumb is always a great strategy to strive to use. If you're in debt, work hard to get to a position where you can use this rule. If you are pure commission, consider building a savings account with “working capital” for your slower months, so you get a steady paycheck with consistent amounts.
Either way, the 50/30/20 rule doesn't always work for everyone but can be a great goal for most to pursue.