The 50/20/30 Budget Rule
A word to the wise:
The 50/20/30 budget rule, made popular in the book “All Your Worth: The Ultimate Lifetime Money Plan”, written by Elizabeth Warren, is simple in theory. Based on your after-tax income; 50% spending on needs, 20% put into savings, and the remaining 30% to be spend on wants. Follow this rule to make progress financially easy and maintainable.
The 50/20/30 rule is something that I basically stumbled across accidentally before every hearing about it. The reason that happened is because the rule works and takes into consideration the average persons spending ability.
I had always heard of two financial rules of thumb:
1) Invest 10% for retirement.
This is a rule I hope everyone’s parents told them. Unfortunately, I didn’t take my parents advice when I was younger and didn’t properly save. I was fairly good with my money, but I was more likely to save for a new guitar than I was to save for retirement.
After finishing college, I took that advice I’d been told at much younger age and put into action.
Being a college graduate is exciting, however, it often comes with student debt. I wanted to continue saving money and realized that 10% wasn’t that bad. It left me enough spending money to enjoy my life, so I figured I could go further and easily put 10% towards my debt payments as well.
By doing that I was putting 20% towards my financial goals. I would also put any left-over money I had at the end of my month towards my debt to accelerate my debt payments. It would often end up being closer to 30%.
10% retirement + 10% debt-reduction = 20% savings and financial goals
2) Your rent or mortgage should only cost 30% of your income.
I am not sure exactly where I originally heard this rule, but it always stuck with me. When I first started looking for apartments I made sure that I only considered places with a maximum of 30% of my after-tax income.
With my rent sitting at approximately 30% of my income, I realized I needed to purchase an affordable car, nothing too fancy or expensive. I made that choice based on the fact that I preferred more spending money and wanted to continue traveling. My car payments ended up costing me roughly 10% of my income.
Just like everyone else, I have to purchase groceries regularly as well as pay for gas. This all added up to around 50%.
30% shelter + 10% car + 10% food & gas = 50% essential needs
The 50/20/30 Budget rule!
Arguably the most important percentage is the first 50%. This is the money allocated for living expenses and essentials. These are all the expenses that we can’t live without.
- Required Transportation
Although the 50% is the most important due to the fact that it is our living expenses. The next 20% is a close second when you consider its importance. This is the money allocated towards financial goals, usually long term.
- Financial goals
- Savings for larger purchases (new car or home)
Now that we’ve properly allocated the first 50% and 20%, the remaining 30% of our money is for wants. This money can basically be used for anything we want.
Now slow down a second. Yes, I did say it’s for wants. But have you really considered what a “want” is? Of course, my wants could include:
- Dinner dates
- Vacation and Travel
- A new bike
- Going out with friends
- A new book
Anyway, you get the picture. This money is great for putting towards your hobbies
or just buying something you like.
But hold on, if my 50% is for necessary payments and 20% is for savings and debt-reduction…that means my remaining 30% has to cover other expenses I have!
- Contact lenses
- Gifts for friends and family
- Using your car for things other than getting to work and back
- Your cellphone plan with unlimited messaging and data to use on Instagram and Snapchat
- and etc.
This category is the most difficult to manage. Because a majority of these costs are one-time purchases and smaller payments, it begins to add up and can quickly get out of control.
My trick for my 30% is to ensure that the second my paycheck comes, I make sure they 50% and 20% are immediately paid for. This allows me to see exactly how much money is remaining for any of my wants. If I don’t pay that 70% first, I often over spend on my 30% and put myself in a financially compromising position.
- Determine your after-tax income. If you don’t know your after-tax income, you can extrapolate your typical paycheck or hourly wage.
$14 x 40 hours x 52 weeks =$29,120
$29,120 x tax (lets assume 15% for this example (0.15)) = $4,368
$29,120 – $4,368 = $24,752 after-tax income
- Break it into 50/20/30.
50% = $12,376
20% = $4,950
30% = $7,425
- Break it down monthly.
50% = $1,032
20% = $413
30% = $619
- Ensure that your finances are allocated properly in each category.
- If you are overspending in 1 category but not in another, you can shift a little money as needed to cover your expenses.
- If you are overspending in all categories, you have a problem!
For the lazy among us! (Yes, I fall into this category at times)
The 80/20 easy money plan. Although I believe the 50/20/30 is far more effective for anyone looking to master their finances, the 80/20 plan is an easy route to take.
Here’s the plan:
- 20% of your money goes towards savings and debt-reduction.
- 80% goes towards everything else.
The reason this is easier is because we aren’t forced to differentiate between needs and wants.
- Is a car a want, or necessary for work?
- Do I need Internet for work, or do I just want it for Netflix?
- Do I need to eat organic food, or is it just a personal preference?
Some people hate budgeting more than anything so the 80/20 is their preferred option. My only concern is that by eliminating the need to split my wants and needs, I am more likely to overspend in the wants and not leave myself enough money for my needs. This will cause me to pull out my credit card to cover any extra expenses.
On the flip side, if you figure you have 80% for everything, you might think you have a ton of money and get an expensive car and fancy apartment. After realizing that those two payments cost you 70% of your income, you can’t spend any money to go out with friends or enjoy your life because all your money has been used for a “need” that is more likely a want!