Budgeting isn't just about crunching numbers — it's about being more mindful of your financial choices and their role in achieving financial success. There’s no one perfect way to budget and there are dozens of ways to budget!
One of the more popular methods is the 50/30/20 rule, and it's best for people who generally don't like planning and tracking their expenses.
Erika Taught Me
- Budget your money as 50% needs, 30% wants, and 20% savings.
- This is a flexible and easy-follow budget.
- It encourages you to re-evaluate your spending habits.
What Is the 50/30/20 Rule?
The 50/30/20 rule is a budgeting method where you divide your take-home pay (your monthly income after taxes) into three categories of spending: needs, wants, and savings. You spend up to 50% on your needs and divide the rest of the money into two sections: 30% for your wants and 20% for your savings and/or debt repayment.
Needs: 50%
“Needs” are expenses that cannot be cut from your budget. Generally speaking, this covers housing, food, and utilities. Minimum payments on debt also fall into this category.
That said, what qualifies as a “need” will vary from person to person. For example, if you commute long distances to work, then your car payment is an essential need — gas, too. Another person may live within walking distance from their workplace and the grocery store, so a car doesn’t factor into their budget at all.
If your current spending on needs exceeds 50% of your monthly take-home pay, take some time to evaluate if some of those expenses might be more “wants” than “needs.” If this is not the case and you simply have a high amount of fixed expenses, the 50/30/20 rule might not be the best budgeting model for you — and that's okay.
Wants: 30%
“Wants” are things you spend money on that are optional. This usually includes entertainment, dining out, travel, shopping, and hobbies. It’s important to incorporate spending that brings you joy! The 50/30/20 rule is not about shaming you into ditching the avocado toast or those custom AirForce 1s. It’s about planning for expenses and setting limits so that enjoying your life now isn’t done at the expense of your future financial well-being.
Savings & Debt: 20%
The final 20% of your take-home pay should be dedicated to your savings goals and debt repayments. What you consider “savings goals” and how you decide to repay your debt is based on your own financial objectives. Savings goals could be anything from growing an emergency fund or contributing to an employer-matching 401k for a house. The objective is to put money away for that particular goal.
Debt repayment should also be a priority with the money allotted to this spending category. The longer it takes to pay down high-interest debt, the more money you pay over time. Allocating extra money beyond the minimum required monthly payment on accounts ensures you’ll pay them down quicker, freeing up more of your money once it’s paid off. Some popular debt repayment strategies are the avalanche method and the snowball method.
- Avalanche method: This debt repayment strategy focuses on paying down that pesky high-interest debt first. You pay only the minimum amount due on all of your accounts except one, so you can put as much money as possible toward paying off the one debt with the highest interest. As each account is paid off, the extra money goes towards the account with the new highest interest rate until all debt is paid off.
- Snowball method: This debt repayment strategy works like the avalanche, in that you pay only the minimum amounts on all accounts except one, but the account you focus on paying down is the one with the smallest balance. As each account is paid off, the extra money goes towards the next smallest balance until all debt is paid off.
Related: How Much Should You Save a Month?
Defining Categories: Wants vs. Needs
When you’re new to budgeting and thinking about your expenses, it can be difficult to distinguish between wants and needs. After all, if you need to wear a suit to your corporate job, is shopping for clothes a need or a want? If having a gym membership and working out is key to your mental health, is that a need or a want? The truth is, it’s okay to just make the best guess and readjust your buckets over time as you get a better handle on your budget.
After you initially plan out your categories, take the time to reflect on your expenses, and consider where you’re able and willing to cut corners. Maybe you’re down to move to a cheaper neighborhood but the thought of trading in your gym membership for YouTube workout videos is where you draw the line. To work for you, a budget needs to be about balancing and accommodating your interests and preferences — you get to decide what’s essential for the 50/30/20 budget and what’s not.
Related: How to Budget: 5 Simple Steps
Pros of the 50/30/20 Rule
There are many budgeting strategies that you can use to manage your money. These are some of the benefits of using the 50/30/20 rule for your spending plan:
- Easy to use: You won’t need complicated calculations or itemized expense tracking to use the 50/30/20 rule. You just write down your monthly income and expense categories, or simply plan out your buckets and use a budgeting app to track and categorize your spending for you.
- It’s flexible: If your needs don’t account for 50% of your pay, or you want to save more than 20%, you can adjust the percentages to make the necessary accommodations. Maybe your budget is more like 60/20/20 or 40/30/30.
- Encourages saving: Any budgeting method that encourages you to save for the future is good, but 20% of your after-tax income is a substantial savings rate, making this method ideal for those who want to prioritize their savings goals.
- Your needs are prioritized: Once identified, you allocate money toward your needs first, which ensures your needs spending is covered before anything else.
Cons of the 50/30/20 Rule
While it’s a popular path to financial management, the 50/30/20 budgeting method isn’t meant for everyone. A few of the drawbacks of using this method are:
- Rising living costs: This budgeting method does not account for inflation. As the cost of things rises, your monthly income doesn’t necessarily increase at the same rate. Inflation makes it harder to afford what you need, meaning the same needs expenses could exceed 50% of your after-tax income over time.
- Not detailed enough: If your money management issue is overspending, it can be harder to identify where this is happening because you’re not tracking individual expenses.
- For stable income: The 50/30/20 method is most effective for W2 employees. There may be better options than this method if you are self-employed, earn a commission, or have inconsistent income. That’s largely because such income is issued pre-tax. To accurately use the 50/30/20 method, you must calculate your taxes and include them in your needs category. While doable, this extra step does make the process more complicated.
What To Do if You’re Not Ready for 50/30/20 Budget Rule
It’s possible that the 50/30/20 rule may be appealing, but it’s not quite compatible with your current financial situation. For example, your needs may be well over 50% of your net income due to a rise in rent. Or, perhaps your income is unstable at the moment. Here are some tips to help you ready your finances to use the 50/30/20 rule:
- Reevaluate your needs and wants: Revisit your buckets. As you get more comfortable with the 50/30/20 rule, you may find that your philosophy about certain spending has changed. Expenses you first identified as “needs” may now be “wants” or certain “wants” might be cut altogether.
- Increase your income: If you need to earn more money to cover your needs, research ways to increase your income, like side hustles, setting up passive income or looking into extra work hours.
- Pay off high-interest debt: By prioritizing paying off high-interest debt accounts, you can free up income that you can then redirect to either your savings, your needs, or your wants.
The great thing about the 50/30/20 budgeting rule is it's easy to use once you’re ready. How you manage your money is ultimately up to you and should be based on the financial goals you set for yourself.
FAQs
I'm nowhere close to these ratios, what can I do?
Don't worry. You know your numbers now and that's important. You can start to slowly work your budget towards this goal. First, understand what category is causing the most trouble. For example, if your needs are 75% of your income, you'll want to focus there. Can you reduce your monthly expenses by moving or paying down debt?
Remember that these are guidelines and don't need to be followed in a strict manner. As long as you are saving enough to meet your goals, you're doing great.
How do you follow a budget?
The first step in following a budget is to start with a realistic budget in the first place. If you've never made a budget before spend a few months understanding your spending habits. If you normally spend $500 a month on groceries, budgeting $250 is only going to set you up for failure.
Once you have a good idea of where you spend your money, set up categories and spending targets for each. Then keep track of what you spend by recording your transactions against the appropriate category so you can see where you stand as the month progresses.
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