"50-30-20 Rule" for Budgeting

Like finding your true soulmate, it’s important to find a money management tool that meets your unique behaviors, lifestyle, and financial goals. Have you experimented with a variety of budgeting methods, but haven’t found one you love or can commit to for more than a couple of “dates?" Maybe the idea of budgeting sounds boring and restrictive. Who needs that? 

A budget that will account for your Needs, Wants, and Savings is one you can have a long-term relationship with. When a budget does not consider your “wants,” it can lead to a “breakup”. In hopes to grab your interest with a simple but effective budgeting method, let’s see if you can make a “love connection” with the 50/30/20 rule for budgeting. 

Harvard bankruptcy expert, Elizabeth Warren, coined the "50/30/20 rule" for spending and saving with her daughter, Amelia Warren Tyagi. They co-authored a book on it in 2005 called "All Your Worth: The Ultimate Lifetime Money Plan."

So how does the “50/30/20” plan work? Thankfully, it is simple and easy to implement and you only have three categories to disperse your money to using this plan. 

First, determine your after-tax income (the amount left after taxes, insurance, and retirement contributions are taken out of your paycheck). Stated another way, after tax income = gross income (-) deductions or what you come home with each payday. 

Secondly, assign or limit 50% of your after-tax income to your Needs & Obligations. People define needs and obligations in a variety of different ways, but here are some things that must be included: food, housing, utilities, insurance, transportation, fuel, and loan payments. 

The challenge with creating a budget is that our “needs & obligations” will likely change each month. For example, some payments are fixed while others may vary and some expenses are paid periodically. Fixed payments cost the same amount each month like rent/house payments or a vehicle loan payment. Items like utilities and food will vary from month-to-month. 

Further, we have periodic payments such as life, auto, or home insurance that may be due annually or twice per year. If you are not putting away money each month to meet your periodic expenses, then your budget can take a turn for the worst, much like “a bad date you can’t end fast enough." It’s very important to have a back-up plan. The best plan is to save a set amount each month so when the bill arrives in six months or a year, you will be ready and able to pay it. This is how to disaster-proof your budget. 

Next, assign or limit 30% of your after-tax income to your Wants. The “wants” category will include things like giving to a charity, eating out, cable television, entertainment, hobbies, and vacations. Oh, and don’t forget “date nights” because those fall into the “wants” category as well. Just remember - it’s important to enjoy life, but balance your "wants" with your "needs” and saving for your future. If you find your percentage is higher than 30% of net pay, then the “wants” category is the place to adjust your budget. Consider lowering the percentage that you can spend on “wants.” For instance, maybe you only have 15% of your income available and that's okay. Practice being content and an attitude of gratitude!

Lastly, assign or limit 20% of your after-tax income to Savings. To save is to limit gratification, but your future self will thank you for it. Here are two very important things to be saving for: an Emergency Fund and Retirement. We never know when the unexpected will happen, which is why having 3-6 months of living expenses in a savings or money market account is a vital step to help us secure our financial well-being. Also, each of us has hopes to experience not having to work at some point in life, and it is important to prepare now to be able to enjoy those years later. 

Are you seeing a possible “love connection” with the “50/30/20” plan? If so, check out the 50/30/20 budget calculator, and read even more about this simple budgeting method.