Budgeting Your Money By Numbers: The 50/20/30 Rule

Written by experts Pat Collins and John Halloran.

There are a number of budgeting plans out there, but one simple strategy we like is the 50/20/30 rule. In her popular book titled ‘All Your Worth: The Ultimate Lifetime Money Plan,’ Senator Elizabeth Warren explained how her 50/20/30 budgeting plan was created as a rough rule-of-thumb to help working-class families plan their spending, to prepare for both the future and unexpected circumstances.

It seems that Americans are very bad at saving, and this has led to high levels of debt. We had $14.3 trillion in total debt as of March 2020, including credit card debt of $438 million. Every working person, couple, or family should create a workable budget for their take-home pay. This is the only way out of our exorbitant amount of debt and to ensure people plan for their retirement. 

The basic rule of the 50/30/20 budgeting plan is to divide up your after-tax income and apportion it to spend: 50% for needs, 30% for wants, and 20% for savings. We feel this is a simple and intuitive plan that ultimately helps people achieve their financial goals.

Most of us need help handling our money wisely, and this system works! It’s a very simple percentage-based budgeting style, but it’s become extremely popular due to its flexibility and simplicity, and how it can be adapted to different circumstances because it’s not based on how much you earn.

Many of us who earn a decent-sized wage or salary are still unsure where our money should be going. Of course, the answer to this question is different for everyone. Some people are anxious to pay down debt so they’re happy to cut out luxuries, like dining out and going to the movies. Others live in city centers where rent is incredibly expensive so they have no choice but to allocate more of their salary to housing.

So, is there any easy answer to this perplexing problem? There’s no exact rule for how you should divide your money because everyone’s situation is different, but we believe the 50/20/30 guideline works really well for most people. The great thing about a percentage-based budget is that you can customize it to your needs, meaning you can adapt the percentages so that the budget works for your specific situation. It may be that your take-home pay is divided into 60/30/10, or even 55/30/15 – it’s up to you to set your own limits.

Regardless of whether you’re just starting your first job or you’re a parent with a small family, the 50/20/30 guideline can help you determine how much you need to allocate each month to each area, plus it can help work out the order in which it should be allocated.

How The 50/20/30 Budget Works

This is a relatively easy guideline to follow because it simply splits everything into three main categories (instead of telling you to break your budget down into (say) 20 different categories). The three categories are fixed costs, financial goals, and flexible spending.

No. 1: Fixed Costs

Fixed costs are bills and expenses that are roughly the same from month to month, such as mortgage payments, rent, car payments, and utilities. This category also includes subscriptions, like a Netflix account or gym membership, because these are amounts you pay each month. We suggest your monthly total of fixed costs should be no more than half your take-home pay.

Our tip: Your fixed costs can be the ideal place to trim if you’re trying to make more room in your budget. Take a closer look at your bills and subscriptions and see if you can reduce, or even cancel, any of them.

No. 2: Financial Goals

We suggest that at least 20% of your take-home pay should be put towards important contributions or payments that help secure your financial foundation. The three essential goals you should be striving for are –

• Saving for retirement,
• Paying down credit card debt, and
• Building an emergency fund.

However, your financial goals might also include a larger saving priority, such as a deposit on a new home.

Our tip: Financial planners typically recommend you automate your debt payments and savings contributions to ensure you continue saving consistently. It’s also the best way of guaranteeing you never miss a payment.

No. 3: Flexible Spending

Flexible spending should take up no more than 30% of your take-home pay. This includes everyday expenses that can, and do, vary from month to month, such as shopping, dining out, groceries, entertainment, hobbies, and gas. Groceries are included in flexible spending because, while food is a necessity, how you spend on food can vary a lot. Sometimes you’ll purchase more groceries for home cooking while at other times you might eat out more. Financial planners advise it’s not really important what you spend your money on in this category, providing you’re always aware of your spending and make a point of keeping under your total flexible budget spending each month.

Our tip: We suggest subtracting your financial goal and fixed costs contributions from your take-home pay to determine your flexible spending amount. Keep in mind that your take-home pay is the amount that hits your bank account after 401(k) contributions and taxes. When you’ve done this calculation, you’ll know the amount you have to spend on whatever your heart desires.

The 50/20/30 Budgeting Plan In Action

Remember that this is just a guide, but it can be an extremely helpful guide when trying to determine where your money is going. This guide can and should be adjusted to suit your own goals and lifestyle.

To explain this concept better, we’ll take a look at two hypothetical budgets – the first one is for Sarah and the second one is for Michael and Susan, a couple.

Sarah

Sarah is 23 years old; she’s a recent graduate and is working in Chicago in her first job. She’s able to pay her bills, meet her student loan payments every month, and also contributes to a Roth IRA.

Annual Income: $36,000

Take-Home Pay After Taxes = $2,250/month. That’s assuming 25% of her salary is consumed by taxes and 401(k) contributions

Fixed Costs Total = $1,100, which is roughly 49% of Sarah’s take-home pay. Her fixed costs include –

• Rent – $775
• Utilities (including internet and phone) – $135
• Transportation – $115
• Subscriptions, including the gym – $75

Financial Goals Total = $475, which is roughly 21% of Sarah’s take-home pay. Her financial goals include –

• Roth IRA contributions – $200
• Student loan – $150
• Backpacking trip fund – $50
• Emergency fund – $75

Flexible Spending Total = $675, which is 30% of Sarah’s take-home pay.

Sarah’s budget is pretty tight, which means her fixed costs are close to the 50% limit. However, she still manages to make her student loan payments on time, plus she allocates 9% of her take-home pay towards retirement, which gives this money plenty of time to grow.

Michael and Susan

Michael and Susan are in their late-30s and have two children close to college age.

Combined Annual Household Income = $150,000

Combined Take-Home Pay After Taxes = $8,750 a month. That’s assuming 30% of both Susan’s and Michaels’ salary goes towards taxes and their 401(k) contributions.

Fixed Costs Total = $3,325, which is 38% of their income. Their fixed costs include –

• Mortgage – $2,000
• Utilities – this includes phone, internet, and TV
• Car payment and Insurance – $775.00
• Gas – $275

Financial Goals Total = $3,235, which is about 37% of their take-home pay. Their financial goals include –

• 529 account contributions – $1,400
• IRA contributions for both parties – $900
• Emergency fund – $535
• Family trip fund – $400

Flexible Spending Total = $2,190, which is roughly 25% of Michael and Susan’s take-home pay.

Michael and Susan’s money situation shows a couple not sticking hard and fast to the 50/20/50 budget guidelines. Fixed costs are ideally ‘no more than 50%’ but Michael and Susan have successfully kept this figure well below that threshold for some time. Their mortgage is travelling nicely and they recently paid off one of their cars.

Because they’ve maintained low fixed costs, they’ve also been contributing to their kids’ 529 accounts. Simultaneously, they’re on track to max out their Roth IRA contributions because, for them, saving for retirement is a higher priority than saving for their children’s college funds. Their reasoning is that you can’t borrow to cover your retirement, but you can borrow for a college education later if required. Michael and Susan have created a nice balance between saving for the future education of their children and their own retirement needs. They have limited their flexible spending to just 25% of their take-home pay to make room for 529 savings.

An Important Point About Retirement

You’ve probably noticed that the 50/20/30 budget guideline only applies to take-home pay. If you make contributions to your retirement prior to your paycheck hitting your bank account, these are not included. So, you might be contributing much more towards your financial goals than suggested by this breakdown. Keeping your retirement savings out of sight can only be a good thing!

Note: Self-employed people typically don’t have retirement contributions withheld from their paychecks, so if you can afford it, we suggest contributing a minimum of 20% of your take-home pay towards your financial goals. This will ensure your contributions are enough to stay on track for retirement.

How To Make The 50/20/30 Guideline Work With Your Budget

If you’re in the process of working out a budget for yourself or your family, we believe you’ll find the 50/20/30 Guideline a useful tool for dividing up your paycheck. Of course, when push comes to shove, how you spend and save your money depends entirely on your goals and your lifestyle.

Final Thought

If it becomes necessary to use your emergency fund, your first allocation of any additional income should be to replace the money used from this account.