Unfortunately, many Americans fail to monitor their spending habits each month. 65% of Americans claimed they don’t know how much they spent last month, according to a 2020 survey conducted by Mint – Intuit. Neglecting to track your spending accurately can lead to financial constraints down the road. Establishing a household budget is the easiest way to know how much you’re earning each month versus what is being spent. There are various personal budgeting methods, but this article will focus on the 50/30/20 rule. We’ll discuss what the rule is, how to implement it and how it can help you track your finances.
What Is The 50/30/20 Rule?
Sen. Elizabeth Warren popularized the 50/30/20 budgeting rule after publishing her book “All Your Worth: The Ultimate Lifetime Money Plan” in 2005. The 50/30/20 rule is a personal budgeting technique that divides your take-home pay into three categories—needs, wants and savings. 50% will be allocated toward necessities, 30% will go toward wants and 20% will be stashed away into a savings fund.
Here is an example of how the 50/30/20 rule would work:
While this rule is one of the most popular and easy-to-use personal budgeting techniques, it’s not an absolute rule. It can be viewed as a rough guideline to help reach your financial goals. For example, if one month you find that you don’t need to spend 30% on nonessentials, you can add more into your savings.
50% Allocated To Needs
When implementing this technique, 50% of your after-tax income should be dedicated to paying for necessities. While it may be easy to conflate the needs and wants category, it’s important to remember that the needs category is meant for things essential for survival. That would include bills such as rent or mortgage payments, groceries, car payments, utilities, insurance, healthcare and minimum debt payments.
30% Toward Wants
Once you have allotted 50% of your monthly income to necessities, you can start thinking about applying 30% of your take-home pay to things you desire but are not completely necessary for survival. As mentioned previously, this group may seem similar to the needs category. However, it’s pretty different. The wants category would incorporate things such as paying for hobbies, vacations, dining out, music and video streaming services, gym membership and much more.
As you may be able to tell, some of these can be misconstrued as necessities, but there’s an optional counterpart that may cost less or be free. For example, instead of dining out, you can cook at home or instead of a gym membership, you work out at home. It’s important to remember that it’s okay to spoil yourself as long as you do so in a financially responsible way.
20% Put Away Into Savings
When implementing the 50/30/20 rule into your budget, the last section will recommend you to put 20% of your monthly income into some sort of savings account. While different budgeting methods may have you put more or less into a savings account, at least 20% of your monthly income going into a savings account is widely recommended by many financial experts. Stowing more than 20% away is good if you can, but anything less, and you might be saving for a lot longer than expected.
There are a variety of savings accounts that will help you accomplish your savings goals. Short-term savings goals like saving for a vacation can go into your standard savings accounts. Emergency funds are a variation of a savings account designed to keep you financially stable when life throws you a curveball. It’s recommended to have at least three to six months’ worth of expenses stashed away for emergencies. While your retirement accounts like a 401(k) or IRA are not technically savings accounts, you should still be putting some of your monthly income into those accounts. If you’re struggling to determine how much to save each month, try using Arizona Central Credit Union’s financial calculators.
How To Put The 50/30/20 Rule Into Practice
If you’ve decided the 50/30/20 rule is a good fit for your financial situation, here is how you can implement it into your monthly budget.
Calculate Your Monthly Income
The first thing you need to do when establishing any budget is to determine your monthly income. Remember, this is what ends up in your bank account. Taxes and workplace benefits such as health and dental insurance and retirement plans will be excluded. If you only have one source of income, the paychecks you receive should be what is calculated.
Calculate a Spending Limit for the Three Categories
Since each category has a different limit, you’ll need to calculate how much you can spend for needs, wants and savings. To accomplish this, you should multiply your monthly income by 0.50 for needs, 0.30 for wants and 0.20 for savings. Once that is complete, you’ll have a better idea of how much you can spend approximately for each category.
Using the numbers in the example above, here is how to calculate your spend limit for each category:
| Category | Total Monthly Income X Category | Category Limit |
|---|---|---|
| Needs | $5,000 X 0.50 | $2,500 |
| Wants | $5,000 X 0.30 | $1,500 |
| Savings | $5,000 X 0.20 | $1,000 |
Track and Follow Your Budget
Monitoring your budget is crucial to financial stability. Keep tabs on your expenses each month. If you feel like you may need to adjust your budget, look at the wants category to see if there’s any unnecessary spending you can eliminate.
How To Determine If The 50/30/20 Rule Is Suitable For You
The 50/30/20 rule is one of the most popular personal budgeting methods because it’s simple and easy to implement. Also, it’s easy to scale once you start making more money. However, there are a few drawbacks that may make this technique not suitable for your financial situation.
Individuals living in areas with a higher cost of living and a low income may find the rule unrealistic to follow. If you live paycheck to paycheck, you may struggle to put 20% into a savings account.
After using the 50/30/20 method for a while, some individuals may find there is slightly too much financial freedom. Spending 30% of your monthly income on nonessential items or services may not be conducive to your long-term financial goals.
Furthermore, this method is a great starting point for individuals looking to budget their money, but it’s not a forever solution. The emphasis or lack thereof on saving is not beneficial to many long-term financial goals like retirement.
Lastly, you may find it hard to follow this budgeting plan if you’re bogged down by heavy debt. It may be difficult to substantially chop down your debt while putting 20% of your monthly income into savings accounts.
Learn More Budgeting And Financial Planning From The Professionals
Establishing a budget is one of the most important things you can do to keep track of your finances. Once a budget is created, it’s equally, if not more important, to stick with it. There are various ways to approach personal budgeting, and the 50/30/20 method is a great starting point. If you have any questions regarding budgeting or any financial advice, check with the professionals at Arizona Central Credit Union.
We offer a range of financial services. Whether you are in the market for a low-interest rate credit card, mortgage, student loan or have general financial-related inquiries, our financial experts can help. Contact us if you have questions or would like to open a bank account.
