If you’re trying to become a better money manager, it’s really helpful to have a clear strategy that ensures you are putting enough of your money in all the right places. The 50/30/20 rule is a budgeting framework that outlines what percentage of your income to allocate for the three of the most important parts of your budget.
The premise is simple — you allocate 50% of your budget for your essentials, 30% for extras, and 20% for debt and savings.
The 50/30/20 rule is simple in theory, and it’s a great maintenance plan. But for anyone with high amounts of debt or those wanting to retire early, the percentages might not work for you.
Today you’re going to learn more about the 50/30/20 plan, how to implement this budgeting strategy, and whether or not it’s the best plan for your financial goals.
What is the 50/30/20 rule?
Harvard bankruptcy professor Elizabeth Warren (U.S. Senator from Massachusetts) and her daughter Amelia Warren Tyagi popularized the 50/30/20 rule in their 2005 book All Your Worth: The Ultimate Lifetime Money Plan.
The goal of this budgeting plan is to give people a simple outline of how to balance their wants, needs, debt, and savings. The 50/30/20 rule starts by knowing your after-tax income, and then dividing that amount as follows:
- 50% of your after-tax income goes towards your needs or financial obligations
- 30% for your wants or non-essential items
- 20% for debt and savings
Here’s the thing, that breakdown might look a little bit off to you if you have a high debt burden, like six-figure student loans, or are trying to retire early. The 50/30/20 rule isn’t going to work for everyone, but it gives you a good baseline to start with.
Breaking down the 50/30/20 rule
50% for needs
The easiest way to understand this category is to think about the expenses you are contractually obligated to pay every month.
This will include the following expenses:
- Groceries (basics, not fancy cheese, a nice steak, or a good bottle of wine)
- Housing costs (mortgage, rent, insurance, repairs, property taxes, etc.)
- Utilities (water, electric, gas, sewer, trash, internet, etc.)
- Health care (including necessary prescriptions and/or treatments)
- Auto costs (insurance, property taxes, maintenance, licensing fees, payments)
- Minimum debt payments (student loans, credit cards, personal loans, etc.)
30% for wants
If it’s a non-essential expenditure, then it falls into this category. This includes anything you don’t absolutely need, like an unlimited data plan for your phone, vacations, gym memberships, dinner out, cable or streaming services, etc.
Everything in this category is considered an optional expense — these are things you can live without.
20% for debt and savings
The 50/30/20 rule asks that you allocate 20% of your after-tax income towards savings and investments. This includes contributions to your emergency fund and retirement accounts.
If you want to make extra debt payments, this is where you budget for those. Remember, minimum payments are a necessity and fall under the 50% category.
Why budgeting with the 50/30/20 rule can work
The 50/30/20 rule is pretty simple in theory, but putting it into practice might take some creative financial planning on your part.
Not only that, this strategy focuses on the cost of living (necessary expenses) that is probably a little lower than what the average family spends each month. In fact, the average American family, taking home a pretax income of ~$75,000 per year, spends 90% of their income on their wants and needs combined. But, there are a few problems with this:
- Only 10% left for savings may not be enough for retirement.
- Interest accrued on debt isn’t included in the 90%, so interest eats into your 10% for savings.
- This is based on pretax numbers — not the money you’re really taking home.
This is why the 50/30/20 plan can work for some people. You start planning from your actual take-home pay and then whittle your needs and expenses down to 80% or less so that you’re saving at a more effective rate.
How to build your own 50/30/20 budget
As with any new budget, prepare by gathering all of your statements, recent paychecks, accounts, receipts, open your budget apps, etc… you can’t just guess here.
If you need help, I highly recommend checking out Personal Capital. This free money app shows you where your money is going, and it lets you track your investments and net worth. Learn more at Personal Capital Review 2019: Free Investment and Net Worth Tracking Tool.
Step 1: Calculate your after-tax income
Your after-tax income is the amount you take home after taxes, Social Security, and Medicare contributions are taken out. However, if you have any deductions for things like a health savings account or 401(k) contributions, you will need to add those figures back in. You will pull those amounts back out in one of the next steps.
For self-employed people, determining your after-tax income can be a little more difficult because your income probably varies from month to month. One option is to use the amount you estimate for your quarterly taxes divided by three to give you a baseline for each month. Flexibility, though, is going to be a necessity.
M$M tip: Read more about self-employment taxes at How to Handle Taxes for Your Side Hustle.
Step 2: Reduce your needs to 50% of your income
Your needs are anything that would dramatically affect your life if you were to go without it. If you’re questioning whether or not something is a need, ask yourself what your life would be like without it.
For example: What would happen if you didn’t have car insurance? If you live anywhere besides Virginia or New Hampshire, you could get in serious legal trouble without it. This is a need.
Another example: What would happen if you didn’t make the minimum payment on your student loans? You will get a ding on your credit score and will accrue more interest. If you go too long without a payment, you can default on your loans. This is a need, but any amount you overpay is calculated into the 20% for savings and debt.
In the 50/30/20 rule, if your needs go over 50% of your after-tax income, you will have to make some adjustments, like:
- Getting rid of your car payment
- Finding ways to save on food costs
- Looking into alternatives to traditional health insurance
- Negotiating for lower rates on some of your bills or shopping around for new servicers
M$M tip: If you need help negotiating lower rates on your cell, cable, or internet service, check out the Trim app. You can learn more about it at Trim App Review 2019: An Easy Way to Save Money on Your Bills.
Step 3: Minimize your wants to 30%
Depending on your current lifestyle, this one might be HARD, like massively difficult. It’s just way too easy to get accustomed to some luxuries now and then, and anything beyond the basics is a want.
The point is, a lot of the things we spend our money on fall into this category. And with the goal of the 50/30/20 rule being financial harmony, you’ll probably need to make some sacrifices and reorder your priorities.
Step 4: Put 20% of your income towards debt and savings
The last part of the 50/30/20 budgeting plan includes funds for:
- Any extra payments or money for your debt (including student loans, credit cards, mortgage, etc.)
- What you put towards your emergency fund
- 401(k) contributions
- Contributions to a health savings account
- Any other retirement contributions
The 50/30/20 rule recommends that you prioritize high-interest rate debt and your emergency fund first. After that, you should focus more on your 20% to retirement savings.
If you’re at least putting 20% of your income towards some combination of debt and savings, you’re probably on a better track than the average American.
When the 50/30/20 rule doesn’t work
Not everyone is going to find that the 50/30/20 rule will work for them, so let’s look at a couple of situations when you might need a different strategy.
If you have a large debt burden
While 20% can help you chip away at your student loans or pay off small amounts of credit card debt, if you have a high debt burden, allocating more than 20% is going to be necessary to take care of that debt quickly and effectively.
The problem is that if you’re only paying the minimum payment on your debt, you’re going to spend a ton of money on interest charges. Also, because the higher your debt burden, the higher your minimum payments are. This can easily eat into a large chunk of your needs category.
If you are working towards financial independence
Plans like FIRE (Financial Independence Retire Early) require that you save at a much higher rate than just 20%. We’re talking savings rates of 50%-65% depending on when you want to retire and what you’re earning.
Saving at that rate is only possible for most people if they drastically cut their spending and increase their income. It also helps if you have a job that pays well over what the median millennial household brings in each year, which is currently at $69,000.
Even if the “retire early” part isn’t in your plans, financial independence alone is a goal for many, with many different meanings too, like being debt-free, able to vacation whenever you want, only work if you want to, etc. Whatever it means to you, it could be hard to get there quickly with the 50/30/20 rule.
What to do if you need more money in your monthly budget
One reason that the 50/30/20 rule won’t work for some people is that they don’t earn enough. If that’s the case for you, one of the best things you can do for yourself is to start a side hustle.
A side hustle lets you earn extra money outside of your normal working hours. It might be spending an extra 3 to 5 hours a week doing digital marketing. You can work as a freelance writer, a virtual assistant, teaching English online, selling stuff on eBay, and more.
There are legitimately a ton of awesome options for decent-paying and flexible side hustles that will give you more money to work with every month.
If you’re interested in starting a side hustle, you can find my favorite side hustle ideas in the articles below:
- 21 Best 2019 Side Hustle Ideas (Make $1,000+ Per Month)
- 17 Best Side Hustles From Home
- Best Side Hustles to Make an Extra $1,000-$2,000 Per Month
- 7 Side Hustles You Can Actually Start in 2019
My final take on the 50/30/20 rule
While there are some situations when the 50/30/20 rule won’t work, this budgeting strategy can and does work for a lot of people. I’d say it’s a good maintenance budget once you’ve paid down a lot, if not all, of your debt.
If you’re able to reduce the amount you spend on your wants and/or needs, you can put more than the prescribed amount towards savings, and this is always a good idea.