What is the 50/30/20 Rule?
What is the 50/30/20 Rule
If you are struggling to contextualize how much you can afford to spend on rent or if you are wondering how much you should be aiming to save for the future, this rule of thumb can help. As with all rules of thumb, it's a helpful starting point, but there are so many other factors to consider, so it shouldn’t be taken as a hard and fast “rule”.
The 50/30/20 Rule is a guideline for how you should spend your money. According to the rule, you should be spending 50% of your income on Needs, 30% on Wants, and 20% on Savings (or Investing).
The rule doesn’t tell you exactly how to spend your money but provides a framework to determine what is a reasonable amount, depending on your income, to spend on your basic needs, how much to spend on the nice-to-haves, and how much should go towards long-term savings.
Let’s say you are looking to buy a new car, and are trying to determine how much you can reasonably afford to spend on a monthly payment. Figure out what 50% of your take-home pay is, then subtract all of your other Needs expenses (housing, bills, insurance, groceries, etc). What’s left is a good ballpark of how much you can reasonably afford to spend on a new car payment.
Limitations
Often, we look for external guidance to tell us exactly what we should be doing. While it can be a helpful framework for making decisions, or a prompt to encourage us to reflect on our spending choices, it’s unrealistic to think that there is some “ideal” spending breakdown that we should all be striving for. There are a lot of scenarios where the 50/30/20 is wildly unrealistic, and comparing your life to this generic “ideal” just makes you feel like a failure.
If you are in a situation where your Needs are especially high right now, it may feel like you are screwed no matter what, so what’s the point in trying. But it’s still helpful to have an idea of what your Needs/Wants/Savings rates are, so you can work to slowly improve them over time.
The 50/30/20 rule should be used as a starting point. Take a look at what the breakdown is for your life now, and see how closely it does (or does not) align. If it doesn’t align, take some time to reflect on the reasons. Do you want to shift your spending? Or is your current spending ratio actually a better fit for your current life stage, values, and priorities?
What counts as a “Need”?
Ultimately, you get to decide what goes into the Needs category. But for the sake of this exercise, we will call any obligations or must-have items as Needs.
Typical Needs:
Groceries
Housing
Transportation - car payment, insurance, gas, maintenance, bus
Medical
Utilities
Childcare
Pet Care
Debt repayments - minimum payments
What counts as a “Want”?
Wants are generally the nice to haves, the indulgences. They add to the quality of your life. But if you lost your job tomorrow, these are the expenses you’d likely start cutting back on.
Typical Wants:
Personal Care items
Clothes
Home decor
Entertainment
Restaurants
Travel
Hobbies
Kids Activities
Gifts
What counts as “Savings/Investing”?
Things that positively improve your net worth fall into this category.
Typical Savings/Investments:
Long-Term Savings (ie building your Emergency Fund or saving for a down payment)
Investments
Retirement Investments (including 401k, 403b, or IRA contributions)
Debt Payments - beyond the minimum payment
While the minimum due on your debts is considered a Need (it’s an obligation and there are consequences if you don’t pay), any additional amount counts as Saving/Investing. These additional payments are paying down the principal loan amount, reducing the amount owed, which positively impacts your overall net worth.
Short-term savings or Savings Buckets is considered a Want or a Need, depending on what you are saving for. If the money is intended to be spent in the next 12ish months, it isn’t impacting your net worth long-term. If you are setting aside money each month for a vacation this year, that money is intended for future travel expenses, so it should be considered a Want.
Calculating your savings rates
I’m a huge advocate for tracking your expenses. Even if you don’t have a traditional budget, having a system to at least track your expenses gives you access to data that can be incredibly insightful.
If you are already tracking and categorizing your expenses, identify which categories fall into Needs/Wants/Saving. Some categories may be a little tricky as they can straddle multiple categories, but just pick which one most closely aligns.
If you aren’t already tracking your spending, print out your most recent bank and credit card statements. Get 3 different colored highlighters, assigning a different color to the 3 expense types. Go through the past month’s statements, highlighting each expense with the appropriate color, and add up the total expenses for each category.
Next, you want to figure out what your total take-home pay is. This sounds easy enough, but if you have any elected paycheck deductions (not including taxes) you want to calculate those back in. If you have $200 a month taken out for health insurance premiums and $300 a month for a 401k, you’ll want to add $200 to your total Needs expenses and $300 to your Savings total. Also, you’ll want to add $500 ($200+$300) to your take-home pay to get an accurate after-tax income.
Finally, you’ll want to divide your category totals by your take-home pay (after adding in any elected payroll deductions).
Below is an example of a family with a take-home pay of $10,000 ($9,000 + $1,000 in elected payroll deductions. To calculate the category percentages, we’ll divide the category totals by $10,000.
An example of a family with a take-home pay of $10,000 ($9,000 + $1,000 in elected payroll deductions. To calculate the category percentages, we’ll divide the category totals by $10,000.
My percentages are way off! Now what?
No one’s expenses are going to perfectly match the 50/30/20 breakdown, and honestly the goal isn’t to necessarily hit them exactly. But seeing where your percentages are different can provide some helpful insights. From there, you can decide if you want to implement some changes to get you closer to the 50/30/20 target. Or you may decide that a different ratio better aligns with your life circumstances, goals, and values.
If your Wants are higher than 30% that might suggest you are taking that YOLO lifestyle to the extreme. There is nothing wrong with spending on luxuries and indulgences, so long as it’s not preventing you from making progress toward your bigger life goals. Use this as your cue to seriously think about what your long-term goals really are. When you have a clearer picture of the future you are building towards it becomes a lot easier to shift some of your Wants spending to the Saving category.
Alternatively, it may just mean that you have lower-than-average Needs expenses right now. If you’ve been living rent-free at your parent’s house, it makes sense that you have lower Needs expenses, leaving more room for Wants or Savings.
If your Needs are notably higher than 50%, this may suggest that your fixed costs are not in alignment with your income, or that you are living beyond your means. Cutting back on your Needs expenses can be particularly challenging. It’s one thing to cut a few subscriptions or skip a shopping trip, but it takes a lot more effort to reduce your housing costs. Because our Needs expenses are often tied to longer-term commitments (lease, mortgage, etc), it’s easy to overextend ourselves with these costs, and then feel stuck in a situation where you don’t have enough to cover your other priorities.
Another challenge with this category is that we’ve labeled them as Needs, but they are often also Wants. Yes, you need a place to live, but do you NEED a 3-bedroom house with a garage? You may need a car to get to your job, but do you need THAT car? Because these expenses check the box of being a need, it is hard for our brain to fully recognize the ways in which our Wants are driving the decision-making. That’s not to say that there is anything wrong with buying a car that has the features you want, so long as you recognize that it may leave less room in your Wants budget.
It’s also possible that your Needs are high because you are just in an incredibly expensive (or lower income) season of life. For parents paying high childcare costs, the 50/30/20 rule is often unrealistic. In a high-cost-of-living area, covering housing, transportation, and food with just 50% of your income is hard enough, but when you add childcare it is often just not feasible.
Sure, you could consider moving your family of 4 into a one-bedroom apartment to make the 50/30/20 rule apply, but understandably, most of us aren’t going to do that. So what tends to happen is that your Needs look more like 60-70+% of your income. With that, you either have to reduce your Wants or Savings accordingly. All that to say, if you are a parent and it feels like there isn’t much left over to spend on your Wants or you are struggling to have much left for Savings, it’s not just you.
Alternatively, if a parent decides to leave the paid workforce and become a stay-at-home parent, it’s likely that the dollar amount spent on the family’s Needs won’t change that much (although Wants and Saving tend to see some cutbacks). But because the family’s income has dropped, those same Needs are now a much larger percentage of the total take-home pay. This isn’t necessarily a problem, as the parents are making an intentional choice that for them, a different ratio better serves their family, at least in this season of life.
The key is to make sure you are thinking about how you might shift when this season is over. Once the kids are out of daycare, maybe you increase the savings rate to play catch up for a while. Or once your income goes up, do you have a plan for where that extra money will go?
Can your Savings rate be too high?
If your savings rate is higher than 20%, it likely means you are prioritizing making financial progress. Maybe you are playing catch up, after getting a late start in investing for retirement. Perhaps you are aggressively paying down debt. Or it may mean that you are earning enough to meet your needs, and have enough left over to comfortably save.
It could also mean that you are seriously restricting your quality of life in order to achieve a financial goal. The 20% savings rate isn’t going to be the right number for everyone, but if you are saving more than this, and feel like you aren’t allowing yourself to really enjoy your life in the present, this may be a good clue to check in with yourself to see if its really worth being so aggressive with saving.
If your savings rate is lower than 20%, first be kind to yourself, most people aren’t saving anywhere near 20%. You may be in a phase of life where this isn’t feasible or it’s not the most pressing priority. If so, just make sure you are looking at ways to slowly improve your savings rate when possible.
Understanding how much of your money is going towards Needs/Wants/Savings can be really enlightening. Even if you aren’t going to make any immediate changes, it’s helpful to understand how your income is being used. If you want some support in implementing some spending changes, schedule a call with Sarah.
