A Guide to Budgeting: 50/30/20 Method Explained
There are countless budgeting methods available, but one of the most popular is the 50/30/20 rule. This budgeting method proposes that 50% of your income should be spent on needs, 30% on wants and 20% on savings. The 50/30/20 budget method helps individuals achieve their financial goals while ensuring they have funds for what they need and want. It's simple, straightforward and easy to use, making this method ideal for budget beginners, students and young professionals.
Understanding the 50/30/20 Budget Rule
Managing your finances involves making wise decisions with your money, and knowing how to budget plays a significant role. The best way to determine whether the 50/30/20 budget method works for you is to understand how it works and how to identify needs, wants and savings.
50% for Needs
Needs are expenses that you must pay no matter what. These mandatory costs include groceries, rent (if you don't own your home) or mortgage payments (if you do). Insurance premiums also fall in this category. If you want to determine what should be part of your needs, think about only the essentials — things that you need to survive.
If you're financing your home, you must make your mortgage payment each month. Remember, defaulting on it may cause you to lose your home.
While eating out is categorized as a want, grocery shopping is a need. Everyone needs to eat, and cooking your own meals is usually the cheapest option.
Your medical expenses affect your savings significantly. Having health insurance ensures you more affordable access to health care, although you’ll need to pay premiums and deductibles.
Car Payments or Public Transportation
Getting from one place to another costs money. Owning a car means paying for fuel and repairs while taking public transportation entails spending on fares.
30% for Wants
Not everything you spend money on is a must-have. Things like that long-awaited vacation, dinner on a Friday night or spa days with your girlfriends are luxuries.
According to the 50/30/20 rule, you can allocate 30% of your income (post-taxes) to discretionary expenses. Remember, everything you put here is optional, but it's a way to reward yourself and may contribute to your overall well-being.
Allocating 30% of your income to discretionary funds may help you save for a trip out of state or to another country.
You can use this part of your budget to purchase new items, like a pair of shoes, a handbag or curtains for the living room.
Cooking your own food may be economical, but a dinner date with your partner or eating out with friends can be a good change of pace.
Streaming video platforms are all the rage these days, and you can use this part of the 50/30/20 rule to pay their monthly fees.
Some expenses allow you to unleash your creativity, whether playing an instrument or taking photographs. Set money aside for lessons and equipment.
20% for Savings and Investments
The 20% in the 50/30/20 budget method goes toward your long-term financial goals. You'll never know when you'll hit a rough patch, and it's always wise to set something aside in preparation for a rainy day. Several things can fall into this category, including putting funds into a savings account, contributing to a 401k or investing in stocks. This part of the budgeting model ensures you have some money set aside for your future.
Your emergency fund helps if you have an unexpected expense (like an accident or illness) and the bills go beyond what your insurance covers. You can also use it if you lose your job to tide you over while looking for employment.
While having a savings account is a step in the right direction, investing your money is an effective way to build wealth. You can invest in stocks or the money market, depending on your risk tolerance level.
It's never too early to begin a nest egg. After all, you don't want to work forever, do you? Contributing to 401ks or IRAs ensures financial independence (or at least allows you to be financially comfortable) during your golden years.
Paying Off Debt
Don't confuse this with debt repayment in your needs — that refers to the minimum amount required. Being debt-free is a financial goal for many people, and using your 20% to make additional payments can get you there faster.
How to Use the 50/30/20 Method
Knowing what the 50%, 30% and 20% ratios mean is only the beginning. Let's see how the 50/30/20 budget method works by applying it to a real-life scenario.
We'll work with a specific amount as post-tax income and break it down according to the 50/30/20 rule. We'll also look at the possible expenses under each ratio and discuss how to perform checks and balances after the entire process.
Identify Your After-Tax Income
The first thing you must do is determine how much you bring home each month. Remember, you're only looking at post-tax money. Let's say that, after taxes, you come up to a monthly income of $4,000.
Divide Your Income Accordingly
Now, let's apply the 50/30/20 rule. Half of your income (50%) goes to your necessities, so that's $2,000. Next, multiply $4,000 by 30% to get your allocation for discretionary spending. That comes to $1,200. The remaining amount ($800) is for your savings — that should be 20% of your income.
Detail Your Needs, Wants, Savings and Debt Repayments
Here is where you'll spend a bit of time. We'll go through each ratio allocation and break it down further. First, let's look at your mandatory expenses. Remember, these are non-negotiables — you need to spend on these to survive. Here's how you can break down the $2,000 for this category:
- Mortgage (or rent): $1,000
- Utilities (electricity, gas, water, internet): $200
- Groceries (food and other household items): $400
- Transportation (gas, public transportation, car insurance): $400
Next, focus on your nice-to-haves. Similarly, let's divide the $1,200 between different wants. Consider the following:
- Dining out and entertainment: $400
- Shopping and personal care: $400
- Hobbies and leisure activities: $200
- Miscellaneous expenses: $200
Lastly, divide your remaining $800 between your savings and debt repayment. You can split it like this:
- Emergency fund: $200
- Retirement savings: $400
- Debt repayment (credit card, student loans, etc.): $200
Follow the Budget and Adjust as Needed
Keep your numbers in mind. At the end of the month, see how well you fared and make the necessary adjustments. Remember, the 50/30/20 budget method allows you to meet your necessary financial obligations while also rewarding yourself and ensuring you have something saved for a rainy day.
Pros and Cons of the 50/30/20 Budgeting Rule
All budgeting models have something different to offer. However, none of them are perfect. The 50/30/20 budget method has benefits and drawbacks, and knowing these can help you decide whether or not it's worth a try.
Simple and easy to use: Unlike other budget models, you don't have to do a lot of tracking. If you're a student or budgeting novice, it's a good starting point for you. You decide which are essential and non-essential expenses, which may not be the same for everyone.
Encourages saving: It ensures that a portion of your income goes into savings, allowing you to grow your nest egg or reduce your debts. How you split this 20% between debt payments and savings is your decision.
Easy to redistribute: Using it for several months allows you to see if you're getting positive outcomes. If you aren’t, it's easy to redistribute amounts within the different categories.
Encourages balanced well-being: Although its primary purpose is to help you achieve your financial goals, it allocates enough funds to enjoy and reward yourself. This prevents frustration and allows you to have a more holistic approach to your well-being.
It might not work for everyone: Individuals with low incomes may have challenges meeting the 50/30/20 ratios. Chances are, most of their funds will go to their needs, not leaving enough (or any) for wants and savings.
It could encourage overspending: 30% of your take-home amount may be significant if you belong to a high-income household (for instance, imagine if you bring home $20,000 monthly). You might have more discretionary spending than necessary as a result.
Progress for multiple financial goals may be slower: You only allot 20% for your savings and debt repayment. If you have both, you'll have to choose between them. If you divide everything, you may see little change, which may be demotivating.
Doesn't specify where the extra money goes: If your total needs or wants don't reach the allocated amount, where do you put the money you don't spend? Although logic states it's best to add it to your savings, there are no clear guidelines.
50/30/20 Budget Rule FAQ
The 50/30/20 budget model can be an effective money management tool, but you must consider several factors before deciding if it's your best option. The answers to these frequently asked questions may provide you with additional information.
Expert Insights on the 50/30/20 Budget Rule
MoneyGeek reached out to professionals with extensive backgrounds in finance to share their insights about using the 50/30/20 rule for money management. Their responses can shed more light on this budgeting tool.
- Are the percentage allocations for the 50/30/20 fixed?
- What kind of consumer would most benefit from the 50/30/20 budgeting method?
- How does the 50/30/20 method compare to other budgeting models?
Accredited Financial Counselor and Education Manager at Money Fit by Debt Reduction Services, Inc.
Certified Financial Planner at SoFi
Division Director, Community & Business Development at Chase
Budgeting is an excellent wealth management tool — and you can explore other models and applications to help you with your financial aspirations. We included these online resources that could provide tips, techniques and strategies for budgeting.
- Zero-Based Budgeting: How to Make Every Dollar Count: Following the 50/30/20 rule is only one approach to budgeting. See if Zero-Based budgeting is more up your alley with MoneyGeek’s comprehensive guide.
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- Budgeting for a Baby: Pregnancy, Infancy and Infertility Treatment: A baby is a blessing, but you can’t deny that getting pregnant (whether or not you need fertility treatments) can be costly. MoneyGeek details potential expenses to help you prepare for them.
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