Raise your hand if you think saving money is hard? You are not alone; merely 36% of American adults think they are on track to save enough money for retirement, according to the Annual Report 2019 published by the Federal Reserve Board.
This is why you need budgeting: so that you can manage your income and expenses better. There are several budgets out there that can work for different needs and lifestyle, but if you want the budgeting process to be as simple as a walk in the park, the 50-30-20 budget might be worth considering.
What is the 50-30-20 Budget?
The 50-30-20 rule involves three easy-peasy steps that will help you prioritize your monthly financial commitments. This budgeting tool divides your post-tax income into 3 groups:
50% – Needs
30% – Wants
20% – Savings
So, for example, if you make $2,000 a month, here’s how you will spend it according to the 50-30-20 rule:
$1,000 will go to your “needs,” or bills that you absolutely must pay, such as rent or mortgage payments, insurance, car payments, groceries, utility bills, minimum debt payment, and healthcare.
$600 will go to your “wants,” or those little extras you don’t need, but they make your life more enjoyable. This includes dining out, going to the movies, tickets to sporting events, a new pair of shoes, latest iPhone, Netflix, a weekend getaway, etc.
$400 will go to your savings and investments. This includes saving money for a rainy day, investing in the stock market, making IRA contributions to a mutual fund account, or extra payments towards any debt you may have, to reduce the principal and future interest owed.
Where Did the 50-30-20 Budget Originate?
Before becoming the first female Senator from Massachusetts, Elizabeth Warren was a law professor at Harvard Law School. While teaching at Harvard, wanted to help middle class families following the 2008 economic crisis. Her efforts- along with daughter Amelia Warren Tyagi- yielded the now-famous 50-30-20 budgeting method.
Warren first introduced this rule in her book All Your Worth: The Ultimate Lifetime Money Plan, published in 2005. It was conceptualized to be a rough, “rule-of-thumb” for working-class families to become financially fit and avoid catastrophes that often stem from unforeseen circumstances.
Taking A Deeper Dive: How To Use the 50-30-20 Rule
First things first: if you want to implement the 50-30-20 budget in your life, you’ll first need to calculate your post-tax income. Post- or after-tax income is simply the amount of money you have left over once you have taken out the state and federal taxes, social security, and Medicare.
Next, split the remaining amount of your income (often referred to as you “take home” earnings) into 3 buckets:
Bucket 1: 50% – Needs
This category covers the basic needs that are musts for basic living. You can include monthly mortgage payments or rent, car payments, health insurance premiums, payments on debts ranging from credit card bills to student loans, as well as food and basic utilities. Ideally, you would be able to comfortably meet your “must-haves” or basic needs with 50% of your post-tax income. If your “needs” exceed 50% of your income, you may need to change the proportions of this budget, consider another budgeting schema, or if you’re able, reduce your “needs” so they make up less than 50% of your post-tax earnings.
Bucket 2: 30% – Wants
Wants are things you do NOT need, but they are “nice to haves”. Wants include things such as tickets to a ballgame, new electronic gadgets, new handbags, dining out at restaurants, going out to the movies, subscriptions to online streaming services (like Hulu or Netflix), or gym memberships. More often than not, you can find really good substitutes for “wants” that cost little to nothing.
Bucket 3: 20% – Savings
This is perhaps the most important category for your future. In the 50-30-20 rule, savings refers to both savings and investments. Savings can take different forms ranging from a savings account and an emergency fund, to money market investments. The investments in this case can include any money you set aside to generate income, such as buying real estate, investing in the stock market, or setting up your retirement accounts.
An easy way to save is to use Acorns, an app and debit card that automatically rounds up the change and invests it in a diversified portfolio, called an exchange traded fund. The average Acorns user saves almost $400/ year. These investments are backed by some of the brightest minds at companies like Blackrock and CNBC, and the service is trusted by over 8 million. Signing up takes less than 5 minutes and will get create a near-instant path to saving for the future.
Why Saving Money Is Vital To Your Financial Future
The reason why every financial guru recommends you to build a strong saving habit is because, first and foremost, it protects you in the event of a financial emergency. It helps you avoid debt, pay for large purchases, reduce the financial stress, and provide you with a greater sense of financial freedom.
Humans might be preparing to travel to Mars, but we still cannot predict the future. And for that reason, saving up a nest egg is a really good idea. Just think about it: how will you pay the bills if you lose your job tomorrow? How do you plan to make money when you are too old to work?
The 50-30-20 rule will help you save money and provide you with a level of financial security that many can only dream.
Make a pledge to yourself that no matter how hard it gets, you will put 20% of your after-tax income into a savings account. The more money you save, the more secure you and your family will be in the future.
How To Implement the 50-30-20 Budgeting Rule?
Here are 4 easy steps to help you make the 50-30-20 budget system a part of life:
Figure out your monthly, take-home income: Add up how much you receive each month in your bank account. If you have an employer-sponsored retirement plan in place, find out how much is withheld, and add that amount back in with your take-home pay. If you are a freelancer or a business owner and pay estimated taxes, reduce that amount from your monthly income accordingly.
Calculate amounts for each category: Multiply your post-tax income by 0.50 (for needs), 0.30 (for wants), and 0.20 (for a financial goal like saving for an emergency fund or buying stock). This will give you a realistic idea of how much you should ideally spend and save.
Don’t confuse debts and savings: Only consider debt payments above the minimum payment required for your 20% savings category. For example, if you are paying extra on a mortgage or credit card debt to pay it off faster, that would be part of the 20% category.
If you’re not sure if you’ll have the discipline to save- and invest- each month, consider using a service like Acorns, and join the 8 million people who save and invest over $390/yr (on average). This debit card and app round up the change from every purchase you make and automatically save and invest it, so not only will you never overspend (buh-bye overdraft fees), but you’ll also be saving money everyday, without even thinking about it!
Stick to it: Track your expenses each month, and tweak your spending where needed in order to stick to these new spending thresholds. So, every time you want to spend more than 30% on your wants or have less than 20% to save up, remember, your financial future is at stake!
Who the 50-30-20 Budget Is NOT For
Financial or not, not every system works for everyone. If you’re lucky enough to be “high-income” or live in an area where costs of living are high, the 50-30-20 budget might not be your best budgeting choice.
For those earning a lot each month, only saving/investing 20% of their post-tax income per month may not be enough, especially if costs of living in their area are low, or they don’t have many debts. People in these financial situations should consider spending less and saving/investing more, in order to financially advance their futures.
On the flip side, the 50-30-20 budget may not be a good choice for people whose necessary monthly expenses surpass 50% of their take home pay. Whether you live in part of the country with a high average rent price, have a large family, or are trying to dig out of debt, saving 20% of your post-tax dollars may not be tenable.
If you like straightforward processes or are just starting out, the 50-30-20 method is a nearly fail-safe budgeting method that’s easy to implement. With this strategy, you only have to focus on three categories, and it’s pretty easy to figure out your needs, wants, and savings situation. This way of budgeting also helps you to account for every dollar coming in and going out.
Arguably, the 50-30-20 rule is a salient way to get your feet wet in the world of budgeting. This simple approach allows you to keep your finances in check, without having to get into the nitty-gritty that many more complex budgets require.
You can adjust the 50-30-20 budgeting rule for your particular needs by changing the percentages to match your financial goals. For example, if saving 20% is out of the question, make it 10% (better than nothing!). Don’t be afraid to think outside the box, and get started today.