The 50/30/20 budgeting rule
If you are thinking you should get your finances in order or you simply are not sure if you have behaving correctly when it comes to money and the way you spend it, the 50/30/20 can be a great starting point.
The 50/30/20 budgeting rule was officially laid out by senator Elisabeth Warren in 2005 in het book “All your worth: The ultimate lifetime money plan”, although it had probably existed for many years before that in one form or another.
The rule is quite simple. It categorizes expenses into three categories; needs, wants and savings, and determinates that you should spend no more than 50% on the needs, no more than 30% on the wants and save at least 20% of your income after taxes.
Examples of the 50/30/20 rule
If you find percentages too abstract let’s take a look at some possible real-life scenarios.
If you are making 25K after taxes per year (or $2,083 per month), you should be allocating this money as follows:
- Needs – $1,041
- Wants – $624
- Savings – $416
If you are making 40K after taxes per year (or $3,333 per month), you should be allocating this money as follows:
- Needs – $1,666
- Wants – $999
- Savings – $666
If you are making 60K after taxes per year (or $5,000 per month), you should be allocating this money as follows:
- Needs – $2,500
- Wants – $1,500
- Savings – $1,000
What are needs, wants and savings
By now you probably already know if you are doing well or if you are far from following this rule, but it’s still worth taking a closer look at each of the three categories. What are “needs”, what are “wants” and what is “savings”?
Needs are those things you need to live. Not to survive but to live. These will include your rent, food, transportation, utilities, etc.
Wants are all those things that you want but that are not essential to live your life. For example having an apartment with a view, going out for dinner, getting a new iPhone or driving to work in a luxury car.
This one is pretty self-explanatory. Saving is the money you put aside into a savings account or some other place were you just keep that money for the future without spending it.
As you can see the “needs” and the “wants” can easily overlap, so it’s up to you to be honest with yourself about the numbers. Think about it his way. Could you live in a cheaper apartment in a cheaper neighborhood? If so, how much rent would you be paying? That number goes into your “needs”, anything in excess of that goes into your “wants”.
Exceptions of the 50/30/20 rule
If you are barely making ends meet you are definitely not going to be saving 20% of your income. Or if you are living in a rural area you’ll probably wont need to spend as much in rent as if you were living in a big city and you’ll be able to spend more on your “wants” or save more.
So, does the 50/30/20 rule work for everyone? No, it doesn’t, but it’s a great starting point or a goal to work towards if you are not there yet.
This rule can also help you put your expenses into perspective. Imagine two people who are struggling to get to the end of each month, one spends 85/10/5 while the other spends 35/60/5. They are both saving 5% of their income which is arguably not enough. One however is only saving 5% because he/she is probably making very little money and his/her “needs” are eating up all income, while the other is spending a lot in the “wants” category and could probably rethink that to save more money every month instead.
So the rule is just a tool that’s there to help you achieve a balanced personal economy. It’s up to you though to be honest about your expenses and be willing to change your habits in order to achieve it.