Woman Budgeting Using The 50 30 20 Rule

The 50/30/20 Rule: A Step-By-Step Guide To Smart Budgeting

Cathie Ericson7-Minute Read
June 08, 2021

Does living within a personal budget sound stifling? The secret may lie in flipping the script and considering it a process that gives you permission to spend on certain things, rather than as a naysayer that’s constantly telling you “no.” One tool that can help you enjoy this freedom is the "50/30/20 rule.” Let’s find out how it could change your financial life.

What Is The 50/30/20 Rule?

The 50/30/20 budget gives families a loose rule of thumb to take inventory of spending habits and recalibrate financial goals. The 50/30/20 rule suggests that the key to financial health is to allot 50% of your after-tax income for needs, 30% for wants, and 20% toward savings.

This budgeting method didn’t come from a financial guru, but rather from Elizabeth Warren, a well-known U.S. senator who was previously a law professor at Harvard. She introduced the term during her time at Harvard, and she and her daughter, Amelia Warren Tyagi, elaborated on the concept in their 2006 book All Your Worth: The Ultimate Lifetime Money Plan.

While just a general rule of thumb, the rule is designed to give people a concrete method for drawing up a blueprint to achieve their financial goals by taking a financial pulse and planning for the future.

The 50/30/20 rule isn’t an exact formula that can be followed by any family in any situation, but it provides a worthy, non-intimidating guide to start making a budget. 

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How Does A 50/30/20 Budget Work?

It’s important to remember that the 50/30/20 budget “rule” is more a guideline than a rule and will change according to your personal needs and situation. Here’s how this budgeting method theory could work in practice.

First, you’ll want to add up all the monthly income from you and others in your household and make a list of all your expenses. Don’t forget ones that might be easy to overlook like insurance or even your cellphone bill. Then you can get to work allocating them to buckets.

50% Toward Needs

You know what a “need” is; it’s something that’s non-negotiable, like a roof over your head. So, even if you might feel like a new pair of shoes is something you “need,” it’s not counted here unless your other shoes have worn out. Here are some of the things that would be categorized as needs:

  • Minimum debt payments
  • Housing expenses
  • Utilities, including internet and cellphone
  • Transportation, including a car payment, gas, parking and insurance if you own your own vehicle; or your transit expenses if you don’t own a car
  • Basic grocery budget
  • Childcare
  • Insurance

As you start to add up these “needs,” you may realize that your “needs” are greater than half of your income, especially if you live in a metro area with high housing expenses such as San Francisco, Los Angeles or New York City. In that case, you’ll need to consider other areas where you can pare back, such as:

  • Minimizing takeout, delivery and prepared foods to keep your grocery bill low
  • Switching to a lower, less expensive tier for your utilities and other services
  • Looking into a smaller car payment or even getting rid of a car if you have two

30% Toward Wants

Now comes the fun part: You get to figure out how much of your budget you’re going to assign to “wants.” If you have a partner, make sure you discuss these so you’re on the same page, or consider allocating a certain amount of money that each person can spend as they choose – for example, if a round of golf is important to you but not to your partner. These “wants” will include purchases in categories such as:

  • Entertainment in the form of streaming services, concerts, dining out, etc.
  • Hobbies and recreational activities such as skiing, golfing and gym memberships
  • Vacations
  • Gourmet or brand name food items
  • Clothing
  • Hobbies
  • Pets

It can be challenging to balance which “wants” are most important, so make sure you’re looking critically at each item and figuring out where you can save for things that aren’t your top priorities. For example, you might decide to make your own coffee at home to allocate that extra $20 to a weekly weekend brunch. Or you might realize that a fancy gym membership isn’t necessary if you can get your workout by walking or doing a class through a streaming service. Finding trade-offs that work for you is the key to making this section of your budget work.

20% Toward Savings

Save early and often is an adage you’ve likely heard. And you might immediately assume that savings means a retirement account – which is certainly important. But savings can also cover other areas. Here are some that might make sense for your budget:

  • 401(k) contributions
  • IRA contributions
  • An emergency fund
  • Debt repayment, such as credit card debt
  • Short-term savings, such as for a down payment for a house or upcoming vacation
  • Education savings, such as a 529 plan

One item on this list that might surprise you is the “emergency fund,” but it’s a savings area to prioritize to help protect your financial future. That’s because emergencies pop up more often than you might think, from a dishwasher that stops working to an unexpected medical bill. Without an emergency fund, you’re more likely to put the expense on a credit card, which often costs far more in the long run as interest charges accrue. If you’re pretty sure that an unplanned $1,000 expense would derail you, you’re not alone: According to one survey, only 40% of people say they could handle that. Prioritizing an emergency fund will help prevent you from having to make a financial mistake.

Considerations Of The 50/30/20 Rule

As we’ve mentioned, the 50/30/20 rule is more a guideline than a real “rule,” and there are some valid criticisms to following it. Here are three to keep in mind.

Doesn’t Work For All Income Ranges

The higher your income, the higher that 50% number is going to be. In fact, if your income is quite low or sporadic, it might seem impossible to only allocate half of it to your basic living expenses. On the other hand if your income is quite high, your needs might not consume half of it and spending 30% on wants can lead to wasteful spending on things you don’t need. In that case, you might decide to allocate more of your income to savings.

Difficult To Apply In High-Cost Areas

When people talk about cost of living, they’re most likely referring to housing budgets, because things like groceries cost relatively the same amount whether you live in a metro area or the Midwest. When the U.S. Department of Housing and Urban Development (HUD) defines “affordable” housing, it suggests that you spend less than 30% of household income on housing costs. That might be unattainable in some areas, like California, which is known for sky-high housing prices. In fact, in Los Angeles, homeowners with a median income spend 39% of it on mortgage payments, while renters spend 46%. If you live in one of those high-priced areas and can’t move, you might have to make some drastic changes to survive on a low income budget.

Financial Goals May Vary

Not everyone has the same financial goals; for example, you might be saving for a down payment on a house or want to start a college fund for your child. If you were working toward a healthy down payment, you might decide to temporarily suspend your retirement savings or cut back on your “wants” to build the fund up faster.

How To Apply The 50/30/20 Rule

Want to see the 50/30/20 rule in action? Consider the case of Tyler, a single person hoping to eventually buy a house of their own.

1. Calculate Your Net Income

First you want to calculate your net income, which is different than your salary because it takes into account your tax payments. While it might seem easy to just take your paycheck and multiply it by two if you’re paid twice a month, it’s more accurate to divide your after-tax annual income by 12, given that some months might have more than two pay periods.

Going back to our example, Tyler is a software engineer whose monthly net income is $8,750.

2. Categorize Your Spending

Here is how Tyler can figure out how much they can spend on various categories.

Net Monthly Income

$[X,XXX]

Needs

$8,750 X 50%

$4,375

Wants

 $8,750 X 30%

$2,625

Goals

$8,750  X 20%

$1,750

 

3. Take Inventory Of Your Current Spending

Now that Tyler knows how much they can spend in each area, they need to figure out how those expenses currently add up. They should take a look at the past few months, up to a year, of spending to see where some budget line items are a fixed monthly sum, such as internet, and where they vary, such as extra summer travel.

Keep in mind that, due to the COVID-19 pandemic, the past year might not be the most accurate way to predict your spending in various categories, given that many areas where you might otherwise have spent were off limits. Try to be realistic about how much you anticipate spending in “wants” categories like travel and entertainment as we move forward. And, note whether you’ll need to bump up some categories like transportation or child care in the “needs” area that might not have recently consumed your budget if you were working from home.

Taking stock of your current reality is the only way to know where you’re actually spending in various categories and gives you a chance to determine if you need to cut back on some overspending habits.

The Bottom Line

If you’re looking for a simple budgeting tool that can get you set on the right road, the 50/30/20 budget is a great place to start as a guideline. But remember that just creating a budget doesn’t actually make sure your spending is in check. Saying you want to only allocate 30% to “wants” is fine, but making sure you don’t creep into a higher percentage is the hard part. That’s why it’s important to track daily spending, and fortunately budgeting apps can make it easy. A budget blueprint is only as good as the follow-through.

Get approved to buy a home.

Rocket Mortgage® lets you get to house hunting sooner.

Cathie Ericson

Cathie Ericson writes about personal finance, real estate, small business, education, retail/ecommerce and other topics for a host of brands and websites. Her work has been featured on major media websites, including U.S. News & World Report, Forbes, Business Insider, The Oregonian, Industry Dive, Boston Globe, CNBC, MSN.com, Realtor.com and Yahoo Finance, among many others. Find her @CathieEricson.com.