50/30/20 Rule: A Simple, Effective Budgeting Tool

Why It Matters:

• Historically, Americans have been among the world’s worst savers. By adopting a 50/30/20 lifestyle, you can make it easier to stick to a budget.
• Using this simple budgeting tool can help you avoid overspending and build more structure into your spending habits.
• Americans are living longer today than ever before. Setting aside 20% of your income for retirement is key to ensuring your senior years are “golden.”
   

As an investor, you may be familiar with the 60/40 rule. Long recommended by financial advisors, this popular guideline encourages investors to put 60% of their investment “eggs” in a riskier (and potentially higher return) stock “basket” and 40% in a more stable (and typically lower return) bond “basket.” As investors near retirement, the bond portion should increase, with the stock portion decreasing correspondingly, along with their age. 

But have you heard of the 50/30/20 rule — a rule that aims to help you manage your money more efficiently and effectively? Though the rule’s name may be new to you, its creator, Senator Elizabeth Warren, likely is not. Together with her daughter, Amelia Warren Tyagi, she introduced this powerful budgeting concept in their 2005 book “All Your Worth: The Ultimate Lifetime Money Plan.”

In a nutshell, the idea is this: To stay on track toward meeting your financial goals, you should set aside 50% of your pre-tax income for “needs.” Another 30% of your income before taxes should be devoted to “wants.” And the final 20% should be earmarked for savings.

50%: Needs

Though different people may define “needs” in different ways, we can probably all agree that needs are the necessities of life. They are your “must haves,” for example:

• Mortgage or rent payments
• Utility bills (gas, electricity, water)
• Transportation (including fuel and car maintenance)
• Insurance (life, health, home, car)
• Basics of living (groceries, clothing, and other supplies)
• Minimum loan payments

And, in an age when remote working and schooling have become more common, a personal computer, smart phone, and internet access probably could be added to this list.

30%: Wants

Now that you’ve taken care of the basics, you can turn your attention to your “wants.” Unlike your needs, your wants will be more personalized. They are the non-essentials that you choose to spend your money on — the niceties that you could live without but that add enjoyment to your life. Wants may include:

• Dining out
• Travel/vacations
• Entertainment (movies, theater, concerts, sporting events)
• Electronics (gaming console, virtual reality headset)
• Memberships (gym, museums)
• Hobbies
• Gifts
• Charitable contributions
• Streaming subscriptions (Netflix, Amazon Prime, HBO)
• Grooming/self-care (hair, skin care, makeup, nails, massage)
• Non-essential clothes (including accessories)
• Specialty groceries (including alcohol)

20%: Savings

Though the smallest portion of your after-tax income should be allocated to savings, that 20% is critical to your financial well-being. True, personal savings soared early in the pandemic as Americans isolated at home, curtailed their spending, and banked their government economic stimulus checks. But historically, Americans have been among the world’s worst savers. At the end of 2020, the personal savings rate in the U.S. amounted to 13.7%.¹ Meanwhile, total consumer debt rose to nearly $14.6 trillion as 2020 came to a close; of that, $820 billion was credit card debt.²

Most financial advisors recommend that you focus first on building up an emergency fund. A useful rule of thumb is to stash three to six months of your pre-tax income in your emergency fund in case you lose your job or suddenly face an unforeseen (and unbudgeted for) event. Once you’ve accumulated enough money in your emergency fund, you can begin saving for your short-term objectives, for example, a down payment on a new home, as well as your intermediate- and long-term financial goals like a child’s college education and retirement.

Getting Started

One of the most appealing features of the 50/30/20 rule is that you don’t need to be a financial whiz to get started on your budgeting plan.

First, take a look at your most recent paystub to calculate your after-tax income; for workers who are not self-employed, start with the amount of your paycheck. To that, add back any non-tax deductions such as your health insurance plan and 401(k) plan (you have established a 401(k) or other retirement plan, haven’t you?). Then, multiply that figure by 0.5 (50%), 0.3 (30%), and 0.2 (20%) to determine how much money should be added to each of your budgeting buckets. It’s that easy!

Of course, there are plenty of budgeting apps available if you eventually want to put together a more detailed and comprehensive budget. But this method will give you a big-picture overview of your monthly spending habits and allow you to make adjustments where necessary. What’s more, you will become more mindful of your spending behaviors, helping you to avoid overspending and stay on course.