Take control of your finances using the 50/30/20 rule
Many of us have tried to stick to an elaborate budget, only to give up soon after. Like sticking to a diet, budgeting becomes more challenging if you don’t start with a basic approach.
To stick to a budget, it’s best to start with a simple system that makes it easy for you to stay consistent. One of the most popular and easy-to-use budgets is the 50/30/20 budgeting method. Let’s find out more about it below.
An Overview of the 50/30/20 Budgeting Method
The 50/30/20 budgeting method, developed by Elizabeth Warren and Amelia Warren Tyagi, is a simple way to keep track of your spending and stick to a budget.
In simple terms, you’ll be spending:
- 50 percent of your income on necessary living expenses
- 30 percent of your income on your wants
- 20 percent of your income for paying debt, saving, and investing
The formula is simple to remember and is easy to apply for people who are new to budgeting. It’s crucial to get into the habit of knowing precisely how you’re spending your money by dividing your finances into the three distinct categories listed above.
One of the best things about this budgeting system is that it sets aside a part of your income for fun. This consideration allows you to manage your money without living an overly frugal lifestyle.
Let’s look at a practical example. If you earn $2,500 a month and were to use the 50/30/20 budgeting method, you’d spend $1,250 on your needs, $750 on your wants, and $500 for saving, investing, and paying down debt.
Where Does the 50/30/20 Rule Come From?
As mentioned earlier, the rule was popularized by Senator Elizabeth Warren (who was then a Harvard law professor) and her daughter, Amelia Warren Tyagi, in the book All Your Worth: The Ultimate Lifestyle Money Plan.
The mother-daughter duo designed this budgeting method as a rough rule of thumb to help working-class families plan their monthly spending and prepare for the future and for unforeseen events.
Who Is The 50/30/20 Budget Good For?
The 50/30/20 budget is perfect for you if it’s your first time budgeting or if you can’t consistently stick to a more complex budgeting system.
When you first start budgeting, it can be exhausting and time-consuming to divide your spending into dozens of categories. So, this budget simplifies things by presenting only three distinct spending categories.
A Closer Look at the Spending Categories
The number you’ll be working with is your monthly after-tax income. This figure is how much you earn after deducting taxes and other payroll deductions.
You’ll put 50% of your income towards your needs. These are the necessary expenses you can’t avoid. More specifically, these expenses include:
- Basic utilities
- Minimum loan payments
Thirty percent of your income will go towards your wants. It’s easy to confuse the need for wants, so you’re going to think carefully about whether an expense is necessary or is nice to have. Wants commonly include:
- Monthly subscriptions
- Dining out
The last category is the savings and debt category. You’ll sock away 20% of your income toward this category. How you use this category depends on your situation, but may cover:
- Emergency funds
- Retirement funds
- Debt repayment
How Do I Apply the 50/30/20 Rule?
The 50/30/20 method is a rough rule of thumb. So, the way you apply it might be different from the way someone else uses it. But in general, this is how it works:
- Calculate your monthly income. As mentioned earlier, we’re working with your after-tax income. Be sure to account for every dollar you earn in a month, especially if you earn from multiple income streams.
- Calculate your spending threshold for each category. Multiply your monthly take-home pay by 0.5 for needs, 0.3 for wants, and 0.2 for savings and debt repayment. Doing so will show you how much you can spend per category.
- Plan your monthly budget around these numbers. Think of these three categories as “buckets” that you can fill each month with monthly spending. List and account for your monthly expenses under the right category and see if you’re spending less than your monthly targets.
- Follow your budget. Don’t forget to track every expense throughout the month. If you find yourself overspending in a category, make adjustments so you can stay on track next month.
Why the 50/30/20 Rule Works
The 50/30/20 rule works because of its simplicity. Many people who want to stick to a budget often have no idea where to start. The 50/30/20 rule makes it easy for anyone to set up a budget and stick to it in the long run.
Learning how to budget your money is one of the cornerstones of good wealth management; however, it is only one piece of the puzzle. Once you’ve created a budget that works for you, you may consider taking other steps to generate wealth for you and your family, such as buying a life insurance policy.
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About Kenneth Christian:
Kenneth has over 20 year’s experience as a financial advisor and wealth manager helping clients nearing retirement, in retirement, clients going through a transition, and working with business owners. He works with clients virtually all over the United States.
Jespersen, C. (2020, December 14). Budget Calculator. NerdWallet. https://www.nerdwallet.com/article/finance/nerdwallet-budget-calculator
Sharkey, S. (2020, November 26). The 50-30-20 Budget Explained – An Easy Budgeting Method To Follow. Money Under 30. https://www.moneyunder30.com/50-30-20-budgeting-method
Vansomeren, L. (2021, February 13). Keep Your Budget Simple With the 50/30/20 Rule. The Balance. https://www.thebalance.com/the-50-30-20-rule-of-thumb-453922