The Simplicity of a 50/30/20 Budget Rule

A budget strategy, like the 50/30/20 Budget Rule, can help ensure your spending doesn’t exceed your earnings and help you plan for the future. Yet fewer than one-third of Americans make and keep a household budget.

Why? Creating a budget can seem overwhelming. People believe it’s too time-consuming to develop and maintain. You have to sort through lots of records like bills, receipts, pay stubs, and bank statements to pull it together. Most people start sorting and filling in information and then abandon the project.

Even with apps and helpful templates, it can feel overcomplicated and nitpicky. It’s easier just to check your bank balance all the time, right? Making sure you are not overdrawn is a good idea, but it doesn’t help you plan out your financial goals. The beauty of a 50/30/20 Budget Rule is it simplifies the budget process, so you might actually use it.

What is a 50/30/20 Budget Rule Anyway?

Senator Elizabeth Warren and her daughter Amelia Warren Tyagi popularized the 50/30/20 Budget Rule in their 2005 book All Your Worth: The Ultimate Lifetime Money Plan. It takes after-tax income and breaks it down into three simple segments: Needs, Wants, and Savings. This simplicity makes it a good budgeting start for folks who have been shying away from creating a budget, believing it was too difficult or took too much time. The 50/30/20 Budget Rule gives a starting point to examine your goals and fine-tune your budget to meet more significant financial challenges like saving for a house or retirement.

50% Needs

Needs should account for just 50% of your after-tax take-home income. They are the bills you must pay to cover your necessary living expenses. These “must-haves” provide for a basic quality of life. Needs include housing, like rent or mortgage payments, basic food, clothing, insurance (health and personal property), healthcare, minimum debt payments (including student loans and tax debt), transportation, and utilities. If you don’t pay them, it causes big problems like eviction, loss of services, and damage to your credit.

Quite honestly, when Needs amount to more than 50% of your Budget, you need to re-evaluate your lifestyle. Downsizing your home or car may be necessary. If you exceed 50%, you are probably living beyond your means. This is even before examining your Wants.

 30% Wants

All the things you spend money on that are not in the essential categories listed above are Wants. They are optional purchases you make beyond the basics. It includes gym memberships, subscription services, takeout coffees, cable, vacations, entertainment, and eating out.

Wants are the little extras that make life more enjoyable. Included in this category are upgrades like a fancier car or higher-end groceries. Have you just upgraded your smartphone? That’s a Want. You could manage with a basic cellphone or no cellphone at all! If there is a cheaper or free option, it is probably a Want. The Want category is the first place to examine if you need to pay down debt and increase your savings to 20%.

20% Savings

The last 20% of your after-tax paycheck is reserved for Savings. This savings category includes retirement (non-workplace) and investments, savings (regular and emergency fund), and debt repayment beyond the minimum payments included in needs. Extra payments to reduce principal debt decrease the future interest owed, making them part of the savings category. I know it seems strange to put debt in savings! Workplace 401ks are not included in this 20% because the funds are taken out pre-tax from your paystub. So, you do not see this money until you start withdrawing it at retirement.

A person making $50,000 annually would take home about $2796 per month after average taxes, FICA, health insurance costs, and 401K contributions. The Needs, Wants, and Savings break down as follows:

• Needs – $1398
• Wants – $839
• Savings – $559

Here is what the breakdown of the 50-30-20 Budget Rule might look like:

Click here for a 50/30/20 Budget Rule Worksheet

Pros and Cons of the 50/30/20 Budget Rule

Pros

A strategy following the 50/30/20 Budget Rule is easy. You can devise your budget by examining your paystub. Tally up your monthly total, determine 50%, 30%, and 20%, and there are your Needs, Wants, and Savings amounts! Easy to do in a simple spreadsheet or notebook.

As a country, we are not great at saving. In 2019 sixty-nine percent of Americans have less than $1,000 in a savings account. Twenty-three percent of Americans would have trouble paying $100 in an emergency. Saving 20% of after-tax pay would significantly improve the average American savings rate of less than 10%.

Cons

The rule of thumb for an emergency fund is to save three to six months of expenses in case of unemployment, illness, or hardship. In these uncertain, turbulent COVID times, I believe you should have at least a six-month reserve, if not more. I think that 20% of each paycheck is not enough to build up an adequate fund if you don’t already have one. It would take too long to build a safety net. According to this budget format, other debt such as excess credit card debt is also supposed to come from this 20%. A better way to build up an emergency fund would be to cut back on Wants expenses and add that money to Savings. 

The COVID-19 pandemic has increased the number of Americans living paycheck to paycheck to approximately 63%. I live in Massachusetts, where housing costs were high to begin with, even outside the cities. In Massachusetts, rents increased 4% in just the past year. House prices have gone up by over 6% in the same period. With a severe shortage of affordable and available housing, I question whether 50% of after-tax income is adequate for the average working person in my state. This is the same situation in other expensive parts of the country, especially for lower-income workers. It’s the unfortunate reality of living in certain areas.

Having 30% of your take-home pay as Wants while having excessive debt seems counterintuitive. If you pay off old credit card debt at high-interest rates in small amounts as part of your 20% savings, you are wasting money. It will help your credit score and wallet to delay a vacation and pay more than a minimum payment on a credit card. That doesn’t mean you can’t plan for a few fun things as you pay down that old debt. The Want part of a budget helps to make the rest of it fun. Everyone wants to treat themselves now and then! Just make sure you actually deserve it. You can use a buffer fund for special treats.

The 50/30/20 Budget Strategy is Worth Following

Overall, the 50/30/20 Budget Rule is a good, basic place to start. Once you get an idea of your income and expenses, you should fine-tune your budget to fit your needs. You may determine you need to split your income differently. Spending your money wisely also makes a difference. Your goals are going to change depending on what you are trying to achieve. Long-term goals should guide you while you work towards smaller goals. Pay off the credit card debt before you buy the house or refinance your mortgage! That will increase your credit score and improve your interest rate. One of the 50/30/20 Budget Rule’s main benefits is it makes you examine your earnings and cash flow. That alone is a valuable exercise.

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