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Throughout my life I’ve found that simple is better, especially when it relates to creating and maintaining systems (budgets included). The more complicated you make something, the more opportunities for failure. This is a big reason I advocate the 50-30-20 budgeting rule, especially for folks just starting out with budgeting.
Table of Contents
What is the 50-30-20 Budgeting Rule?
The 50-30-20 budgeting rule is a simple budget breakdown that encourages separating your monthly income into three divisions: 50% of your budget goes towards needs, 30% towards wants, and 20% towards savings.
Needs
Needs are the expenses that you have to pay to survive. This includes food, shelter, utilities (water, sewer, electric, gas, etc.), healthcare, car payments, etc. This does not include things like cable, internet, eating out, vacations, other entertainment, etc. If you’re unsure of whether or not something is a need, it’s best to assume it’s a want.
Wants
Wants are all of those expenses that don’t fit into the “needs” category. I know I listed car payments and shelter above, but it could be argued that if you have an overpriced home or car, it should be listed in the wants category because you could downsize both.
Savings
Savings are the expenses that go towards your savings and retirements accounts. 20% towards savings should be a minimum.
The 20% is can be tied back to the 4% withdrawal rule which essentially states that if you want to make the same income in retirement, you can withdraw 4% from your retirement and never run out money in retirement.
As a disclaimer, this is just a rule of thumb and assumes that the stock market behaves similar to how it has in the past.
What this roughly equates to is needing 25x your income to retire. Saving 20% of your income and assuming a 5% average rate of return, you’ll need to save for 41 years to retire. If you start early, this puts most people in their 60’s and also eligible (or close to eligible) for social security (assuming its still there) when they retire.
If you want to retire earlier you either need to save more or plan to live on less than your current income.
How to Use the 50-30-20 Budgeting Rule?
I personally use the 50-30-20 budgeting rule as a check on my budget. I use it to make sure the budget we’ve created and adhere to at least meets the minimum requirements used in the 50-30-20 budgeting rule. To use the 50-30-20 budgeting rule, you first need to have a baseline for your income and expenses.
Step 1: Create a Simple Monthly Household Budget
Probably the most important thing you can do to get your finances on track is to create a simple monthly household budget. It’s easy to create. Track and record your gross income and expenses for the month. This is where your money is currently going.
Determine your financial goals, both short term and long term. From these goals, determine what expenses are most important to you and what you can live with less of and without.
Using your gross income, tell each dollar where to go (i.e. 15% towards food, 25% towards housing or rent, etc.). By creating a budget that has a zero balance at the month, you are in full control over each dollar you spend.
Related: Benefits of Managing Your Budget Effectively
Step 2: Plug Your Budget Items Into the 50-30-20 Budgeting Rule
Now that you have a budget, you know where all of your money should be going each month. Take your budget items and assign them as either a need, want, or savings budget item. Add up each category and divide it by the whole to get the percentages.
If you are over on the wants or under on the savings, you need to look at your budget and adjust. Your budget most likely isn’t going to meet the 50-30-20 budgeting rule exactly. In general, you should strive to meet your needs and save as much as you can.
Step 3: Implement Your Budget, Review Each Month, and Adjust as Necessary
The final step is to review your budget and spending each month, and continue to adjust until you find a budget that works for you and keeps you on track with your savings goals.
You’ll experience changes in your budget as you experience life changes (get married, buy a house, have a child, etc.). As these changes occur, make sure to revisit your budget and adjust to meet your new lifestyle.
Create an Emergency Fund
To ensure that an financial emergency doesn’t derail your savings goals, you need to create an emergency fund. You can start off with a small emergency fund (~$1,000) to get started until you pay off your debts, but the general rule of thumb is to save 3-6 months of expenses. This varies by how you perceive your job security and how consistent your pay is (i.e. if you’re a real estate agent or sales person, you may consider saving more than just 3 months).
Invest Your Savings
Once you’ve created an emergency fund, you need to put your money to work for you. The 20% savings in the 50-30-20 budgeting rule assumes that you are going to invest your savings over time.
Take Advantage of Any Employer Match
When looking to invest, make sure to take advantage of any “free money” offered by your employer first. If they offer a match of some kind on your 401k contributions, make sure to invest enough to take full advantage of the match.
Other Tax Advantaged Retirement Accounts
Once you’ve taken advantage of any “free money” offered by your employer or others, feel free to invest your money in tax-advantaged retirement accounts as you see fit. Make sure to read the rules before investing (i.e. the cutoff for eligibility, how much you can invest, etc.)
I personally recommend investing with Vanguard in a tax-advantaged retirement account (I use a Roth IRA in addition to my pension plan) because they have low fee index funds that perform well. If you invest in the index fund that tracks the stock market, you’ll do as well as the stock market overall which on average is considerably higher than the 5% mentioned above.
Conclusion
The 50-30-20 budgeting rule is a simple way to ensure you’re tracking towards the minimum savings necessary to retire. Make sure to invest your savings as soon as possible. As you earn more or decrease expenses, put that extra money towards savings and investments. The sooner you start putting money to work for you, the sooner you’ll reach financial independence.
Have you used the 50-30-20 budgeting rule? Did it help you with your finances?