Explaining the 50/30/20 budget rule

With so many budgeting strategies, it can be difficult to pick the right one for you. Consider the 50/30/20 rule, which splits your spending into three categories based on percentages and purposes, if you’re looking for a technique that’s easy to follow and isn’t too forbidding.

What is the 50/30/20 budget rule?

The 50/30/20 budget rule slices your monthly pay to cover three different categories of expenses:

• 50% of your after-tax income (take-home pay) covers needs. These are essentials, such as housing, food and transportation.
• 30% covers wants, which can range from dinners out to vacations to charity.
• 20% covers debt repayment and savings, such as retirement contributions and credit card payments.

The rule was popularized by U.S. Sen. Elizabeth Warren and her daughter Amelia Warren Tyagi in their 2006 book, “All Your Worth: The Ultimate Lifetime Money Plan.”

Rather than putting money in envelopes or sacrificing all of your debt, think of the 50/30/20 budget as providing guidelines to help you gain control over your finances. 

How to calculate the 50/30/20 rule

The first step is to get a handle on your monthly after-tax income. This should be a painless process, but in case you don’t know how much is deposited into your checking account every couple of weeks, you can consult your pay stub for the figure. 

Those who are paid twice a month need only to multiply the net income from their paystub by two to get their monthly after-tax income. 

Those paid biweekly have a choice to make: You can base your budget on two biweekly paychecks or you can multiply one paycheck by 26 and then divide by 12. 

The former accounts for just 24 yearly paychecks, meaning the remaining two will be treated like a delightful surprise. The latter takes into account all of your income. 

Here are your next steps:

• Multiply your monthly take-home pay by 50%, 30% and 20% to come up with the recommended spending limits for each category.
• Review your expenses to see how the 50/30/20 calculations compare to your reality. This is where your bank, credit card and loan statements come in handy. To get a more precise reflection of your expenses, look at two or three months’ worth of them and then come up with a monthly average for that period.
• Once you’ve filled up each expense bucket, figure out whether you’re on track with sticking to the 50/30/20 rule or if you need to make some spending adjustments so your expenses line up with each column.

It’s worth noting that some expenses might not fall into only the wants, needs or debt/savings category. If this is the case, split an expense (such as your cellphone bill) into a couple of categories. The math doesn’t need to be perfect, but you should be as accurate as you can.

Examples of the 50/30/20 rule

Let’s say your monthly take-home pay is $5,000. If you apply the 50/30/20 rule, you’d allocate:

• $2,500 (50%) for needs.
• $1,500 (30%) for wants.
• $1,000 (20%) for debt repayment and savings.

Based on those numbers, let’s look at how each of these three spending categories might shape up.

Needs (50%)

Needs (30%)

Debt/savings (20%)

These are just hypothetical examples of how someone might divvy up $5,000 a month in tax-home pay. Your expenses will vary according to factors such as location and lifestyle. And, of course, your spending might change over time when you pay off debt, for instance, or if you move to a different city.

How to budget monthly

If you’re motivated to follow the 50/30/20 rule, then you’ll need to create a monthly budget. Fortunately, it’s not as tough to do as it might seem.

A budget can help you from living paycheck-to-paycheck, put you on the path toward being debt-free and give you a shot at living comfortably in retirement.

To budget monthly, you’ll need to:

• Gather all of your financial statements. This includes pay stubs, bank statements, credit card statements and utility bills.
• Calculate your after-tax income (tax-home pay).
• List all of your expenses and average them over the course of two or three months.
• Put the expenses into two categories, fixed and variable. Fixed expenses include rent and utility bills, while variable expenses include restaurant meals and travel.
• Calculate the income totals and expense totals, and subtract the expenses from the income.
• Study the results. Determine whether you need to make spending adjustments or scrape together more income.

Once you’ve gone through this exercise, it should be fairly easy to maintain your monthly budgeting with help from a spreadsheet or a budget app. If you’re old-school, you might opt to track your budget with a pen and paper.

The importance of saving

Part of the 50/30/20 rule involves saving money for retirement and emergencies.

Setting aside money can help you prepare for the unprepared. For instance, an emergency fund can benefit you if you’ve been laid off, you’ve wound up with a pile of medical bills or you’re facing a huge car repair bill.

It can also give you a sense of financial security. That’s key for the 37% of Americans, according to the Federal Reserve, who can’t cover an unexpected $400 expense with cash.

Meanwhile, saving money for retirement can help ensure a better future once you’ve left the workforce. Roughly half of American families are at risk of falling into a lower standard of living once they retire, according to research from the Boston College Center for Retirement Research. 

Setting aside a little bit each month will redound to your long-term financial sanity.