How to Budget Using the 50/30/20 Rule
Are you new to budgeting or overwhelmed by getting started? You may have heard of Elizabeth Warren’s 50/30/20 rule that can help you manage your budget – especially if you don’t want to have to track your spending in detailed categories, which can get overwhelming and be time consuming.
The 50/30/20 rule budget only requires you to categorize your expenses into three main categories: needs, wants, and financial goals. This sounds simple enough, right?
The biggest benefit of this percentage-based budgeting method is that it reduces the amount of time needed to keep track of your budget. Instead, it focuses on the big picture and your financial health as a whole. It also provides guidelines for how much to spend, and how much to save, which some may find easier to manage – especially if they are having trouble managing their money.
What is a Percentage-Based Budget?
Percentage-based budgeting is one of the simplest budgeting methods. You simply take a predetermined percentage of your income to help you determine how much money you should be spending and in each category.
Elizabeth Warren popularized the 50/30/20 method in her book All Your Worth: The Ultimate Lifetime Money Plan. Dave Ramsey recommends a percentage-based budget as well but breaks his percentage-based budget down into significantly more categories such as food and charitable giving.
If you’re interested in starting a percentage-based budget using the 50/30/20 rule, you can set it up in four easy steps. This article will walk you through creating your budget, as well as provide a quick example to get you on the right track.
4 Easy Steps to Set Up a 50/30/20 Budget
Calculate Your After-Tax Income
Calculating your after-tax income is simple. Start with your take-home pay on your paycheck and add back any deductions that aren’t taxes. These items may include health insurance, retirement contributions, life insurance, short-term disability insurance, and more.
Example: Beth’s take-home pay is $3,072 per month. However, she pays $323 in healthcare, and $105 for her retirement account. Therefore, Beth makes $3,500 per month after taxes, but before her deductions.
Budget 50 Percent to Your Needs
After you’ve calculated your after-tax income, you need to calculate 50 percent of that amount to allocate to your needs. Each person will have slightly different personal definitions of needs and wants, but these are some general guidelines to follow.
Needs are expenses that you must have in your budget in order to live no matter what. These are expenses like rent or mortgage, utilities, transportation and healthcare. Some people also include the bare minimum payments on their debts in this category, and the minimum amounts they can spend on clothing, food, and supplies to live.
If you find that you are spending significantly more than 50 percent of your after-tax income to cover your needs, you may need to cut back. Perhaps you should consider moving into a smaller, less expensive home or apartment. You might need to trade down to an older car with cheaper car payments and insurance. If minimum debt payments are what is pushing you over the limit, you may need to pay off a few balances so that you no longer have those minimum payments.
When you first start tracking your expenses for the 50/30/20 rule, your spending likely won’t fit perfectly. The goal is to get your spending more in line with that ratio for a healthier financial picture.
Example: Beth can spend $1,750 on her needs. She pays rent ($850), a car payment ($280), electric ($100), water ($80), car insurance ($115), and health insurance premiums ($323). This is actually Beth’s total expenses for the needs category – leaving her $0 for food, clothing, and other supplies. In order to follow the 50/30/20 rule, Beth would need to cut down on her expenses a little to make room for things like food and clothing. Alternatively, Beth could possibly spend a bit less on the "wants" category, and allocate more money to the more important "needs" category.
Budget 30 Percent to Your Wants
Next, you will calculate 30 percent of your after-tax income to budget towards your wants. Wants are expenses that you choose to spend money on, but that you don’t necessarily need to live. This category includes alcohol, internet, cable, shopping, vacations, entertainment, gifts, dining out, and other luxuries.
This is also where you would include additional money for clothing, food, or supplies that go beyond the absolute minimum that you need to live.
Thirty percent of your after-tax income sounds like a lot, at first. However, when you take into account what you actually spend on “wants” vs. “needs” – like your home’s cable bill and that unlimited text messaging plan – that money goes very quickly.
Example: Beth has $1,050 to allocate towards the “wants” category. She pays $75 for internet and $50 for her cell phone plan. Since she did not have enough space in her “needs” to cover for her food and clothing, she will take $250 per month for food and $100 per month for clothing to put towards the excess needs. Beth pays $30 a month for her gym membership, and she likes to eat lunch out three times per week with her coworkers. This leaves Beth with about $455 per month in discretionary spending for entertainment or putting towards additional debt.
Budget 20 Percent to Your Savings or Financial Goals
The remaining 20 percent of your after-tax pay goes towards your financial goals. This includes saving and paying off debt more quickly than required. You can use this money for saving for retirement, building an emergency fund, saving up for a down payment on a house or paying extra on your credit cards. Keep in mind that paycheck deductions for your retirement account do go toward this category.
If your 20 percent has enough excess, you should also consider investing it. Investing your money allows it to grow over time. There are many types of investment opportunities, including stocks, certificates of deposit, or bonds. Each of these offers a rate of return on your money over the long-term. The type of investment that is right for you will depend on a variety of factors.
Example: Beth should have at least $700 to allocate her financial goals. She contributes $105 per month to her retirement account. The rest of the money could go towards additional investments, building an emergency fund, making extra payments on student loans or a mortgage, or any other financial goals.
When Should You Use a Percentage-Based Budget?
Percentage-based budgets work extremely well for those who are new to budgeting, or those who have had trouble sticking to a more complex budget in the past. It can also provide some guidelines for anyone who is interested to see how their current financial picture looks in relation to what the experts might recommend.
However, it can be very challenging to lower your “needs” to 50 percent of your income, even if that is considered ideal. As with the Beth example, many people will need to use some of their "wants" budget to account for the excess in their "needs", especially when they first start out.
That being said, there are some additional disadvantages to percentage-based budgeting that may make it problematic for long-term usage.
When Does a Percentage-Based Budget Not Work?
Percentage-based budgeting does not typically work with extreme incomes (either high or low). For example, a one-income family that lives in a high cost of living are area could really struggle to conform to these percentage guidelines. Their housing costs alone could eat up a large part of the budget.
While the “experts” would say that the solution is to be more frugal and not to change the percentages, there is realistically only so much you can do. You may be locked into a lease, or you may not be able to sell your home quickly if you are looking to move.
On the opposite end of the spectrum, there is a certain point where someone may make so much money – and therefore their “needs” just do not come to 50 percent of their total income. This budgeting method also tends to allocate too much money to “wants” and not enough to “financial goals.” Obviously, this scenario is much less common than the previous one, but it is still something to consider.
Another problem with percentage-based budgeting is that it doesn’t address lifestyle inflation. Lifestyle inflation refers to the practice of increasing your spending when your income goes up. That might mean upgrading your car or buying the latest cell phone when you get a raise at work. Lifestyle inflation makes it extra challenging to get out of debt, save for retirement, or reach bigger financial goals. It does not make sense to spend more just because you make more if you are perfectly happy with the way things are.
Additionally, a percentage-based budget does not allow much flexibility for people to budget for things that are truly important to them. Money is incredibly personal, and therefore, your budget needs to fit your life.
Tips for Using a Percentage-Based Budget
Distinguishing between “wants” and “needs” is probably the trickiest part of this budgeting method. Keep in mind that any payment you can get rid of with only a minor inconvenience is a “want.” Obviously, this will shake out differently depending on circumstances.
For example, if you are a young adult with a full-time office job, your home upgraded internet is likely a “want.” It would be great to have it, but you could probably get by with the baseline internet. On the other hand, if you are that same young man, but you freelance for a living from home, your internet is probably a “need.”
Minimum debt payments are considered “needs” because your credit score will be negatively impacted if you do not pay the minimum. A lower credit score can significantly impact your quality of life (as well as how much you will pay for other things like cars and houses throughout your life) so making those minimum payments is really important. However, if you do not have enough room in your “needs” category, you can also pull these from your “wants” category – it will just leave you less money for discretionary spending.
Another consideration for percentage-based budgeting is that you want to make sure the percentages you use align with your personal financial goals. While 50/30/20 is a guideline, it may not be the right ratio for your specific lifestyle.
If you can’t seem to get your bills and spending to match up with the 50/30/20 rule (and it isn’t because you go shopping every weekend or plan multiple lavish vacations every year), then you may need to adjust the percentages slightly to match your financial picture. Individual circumstances, such as cost-of-living in your area, may make an exact 50/30/20 percentage impractical. If adjustments do not seem to work, or you feel you need more detail for your budget, there are plenty of other budgeting methods you can try as well.
You should also keep in mind that it doesn’t really matter how you budget your money. Every single budget is entirely dependent on the person who is creating it. Following strict budgeting guidelines without evaluating your own specific financial situation will not work for the long-term. For example, maybe saving for a down payment on a home is not a priority for you, but driving a slightly more expensive car is. And that’s okay.
The key to any budget is to create an understanding of how you are spending your money and where it is going. Then, you’ll want to align that to what you want to be doing with your money – such as saving for retirement, saving for a house down payment, or getting out of debt. This is what will help you reach your ultimate financial goals and live the life you want.
About the Author
Melinda Pettijohn is an expert personal financial writer with more than 10 years of experience in the industry. She covers topics ranging from budgeting, additional ways to make money, credit cards, managing debt, paying for college, and more. As a mom of three kids, she especially loves sharing insights on how to make the most of your money while raising a family.