- The 50/30/20 rule is a budgeting approach that can help you increase your monthly savings.
- The three categories of this approach are needs, wants, and savings and debt repayment.
- The 50/30/20 approach isn’t right for everyone, so it’s worth considering both the benefits and drawbacks.
Budgeting is a crucial part of financial health that allows you to keep track of your money and reach your savings goals. Whether you are already using a budgeting app for personal finance, or just looking to save more money regularly, the 50/30/20 rule can be a helpful general guide to enable you to meet personal financial goals.
What is the 50/30/20 rule?
Elizabeth Warren and her daughter Amelia Warren Tyagi popularized the 50/30/20 budgeting method in their book All Your Worth: The Ultimate Lifetime Money Plan.
The 50/30/20 rule divides after-tax income into three categories: needs, wants and savings and debt repayment. The rule recommends allocating 50% of your income for needs, 30% for wants and 20% for savings or paying off debt beyond the minimum monthly amounts.
This is not a hard-and-fast rule, however. You may desire to tweak the 50/30/20 ratio to suit your income and help you reach your personal savings goals. For instance, if you want to focus on paying off debts, you may want to augment your ratio to 50/20/30. Or, if your cost of living has risen and you’re more focused on paying for day-to-day essentials, rather than wants, you can adjust to 60/20/20 to make sure you can pay off your expenses while also saving.
The 50/30/20 rule and after-tax income
The 50/30/20 rule is ideally based on after-tax income (also known as net income or take-home pay) rather than gross (or pretax) income. Your take-home pay can be calculated by subtracting any taxes and pretax payroll deductions from your gross income.
Things that may be deducted from pretax income, and therefore not factored into your 50/30/20 budget, include:
- Health insurance premiums
- Federal, state and local income taxes
- Social Security and Medicare contributions
- Retirement plan contributions (such as a Roth IRA, 401(k) or other retirement accounts)
50% of your income: Needs
Your “needs” (sometimes called “essentials”) include core living expenses that you need to pay off each month. Examples include:
- Housing (such as a rent or mortgage payment)
- Minimum credit card bill payments
- Minimum debt payments (such as a student loan)
- Transportation (such as a car payment and/or car insurance)
Minimum debt payments are filed under “needs,” even though “debt repayment” (beyond minimum requirements) typically falls under the 20% category. This is because missing minimum payments can seriously damage your credit.
30% of your income: Wants
Your “wants” (sometimes called “non-essentials”) are different from “needs.” Separating your “wants” category from your “needs” category can help limit overspending, no matter your income. Examples include:
- Dining out
- Monthly subscriptions
20% of your income: Savings and debt repayment
Like many other budgeting methods, the 50/30/20 method involves directing a considerable portion of your money toward savings and proactively paying off debt. This may be different than what you're used to, but it can be beneficial, as dedicating a portion of your monthly income to a savings account can help eliminate debt and build a bigger nest egg.
Although the “needs” category encompasses minimum debt repayments, this 20% category involves channeling additional money, as possible, toward debts to pay them off faster and save money on interest.
Additionally, the 20% category generally includes investments. This can mean several different things, including contributing to an emergency fund, making retirement contributions and investing in stocks. It can be prudent to prioritize an emergency fund, sufficient to cover several months' worth of living expenses, before pursuing other investments.
Depending on your financial situation, you may choose to allocate more of the funds in this 20% category towards saving or investing. For instance, someone without a 401(k) or other employer-subsidized retirement savings plan may want to save more aggressively for retirement.
Examples of savings and debt repayment included in the 20% category are wide-ranging.
|Short-term savings goals/debt repayment||Long-term savings goals|
Knowing the best bank account in which to store your savings is essential to meeting your financial goals.
|What Is the Best Bank Account for Savings?|
|The best bank account to build savings is often an interest savings or money market account, where you can accrue interest on your savings balances as well as store them safely. There are different types of savings accounts worth exploring before you make your choice.|
50/30/20 rule example
Here's an example of how to calculate a 50/30/20 budget. This approach can be used for both individuals and households:
- Monthly take-home income: $4,000
- Needs (50% of net income): $2,000
- Wants (30% of net income): $1,200
- Savings and debt repayment (20% of net income): $800
Benefits and drawbacks of the 50/30/20 rule
The 50/30/20 rule is merely a framework, rather than a hard-and-fast financial rule that everyone should follow. Here's what to consider, before you decide to use the 50/30/20 budgeting method.
Benefits of the 50/30/20 rule
- May help you save more money than budgeting without clear guidelines
- Gives you a framework for how much you can spend each month
- Helps you organize your money and spending and make it easier to allocate money each month
- Boosts your savings and enables you to reach your short-term and long-term financial goals
Drawbacks of the 50/30/20 rule
- Some people may need more than 50% of their income to cover essentials
- May encourage people with higher incomes to spend more on wants then they otherwise might
- May be less helpful for people who are prioritizing paying off significant debt
- Doesn’t take into account a person’s individual financial situation, and instead acts as a blanket approach
Why is saving money important?
No matter what method you choose, boosting your monthly savings is an extremely important part of strong financial health. Benefits include increased financial stability, being better organized with personal finances and improving your credit score.
If you have questions about budgeting, or if you would like to discover all of your options, it can be helpful to speak with a financial advisor for personalized help reaching short- and long-term savings goals.