Using the 50/20/30 budget rule is a simple and smart way to figure out how to spend your money after taxes. The “50% necessities, 30% wants, and 20% savings” formula was created by U.S. Senator Elizabeth Warren and published in her book All Your Worth: The Ultimate Lifetime Money Plan.
The 50/20/30 budget rule’s significance and how it might assist you in achieving your financial objectives are covered in this article.
In a Nutshell
- Necessities including rent or mortgage payments, cars, food, insurance, health care, minimum debt payments, and utilities should each receive 50% of after tax income.
- Wants like going out to dinner and a movie, that new handbag, tickets to sporting events, vacations, the newest technological device, and high speed Internet should receive 30% of after tax income.
- Twenty percent (20%) of after tax income should be set aside for savings, such as by funding an emergency fund in a bank savings account, contributing to a mutual fund IRA, and making stock market investments.
50%: Need
Necessities are bills that you have to pay and that you need to pay in order to live. These include rent or mortgage payments, a car, food, insurance, health care, minimum debt payments, and utilities. These are your “must haves.” The “necessities” category does not include items that are extras, such as HBO, Netflix, Starbucks, and dining out.
Budgeting is not just for people who do not have enough money. It is for everyone who wants to ensure that their money is enough.
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Half of your after tax income should be all you need to cover your needs and obligations. If you spend more than that on your needs, you will have to cut back on wants or try to downsize your lifestyle, perhaps with a smaller house or a more modest car. Maybe the solution is to carpool or take public transportation to work, or cook at home more often.
30%: Wants
Wants are all the things you spend money on that are not absolutely essential. This includes going out to dinner and a movie, that new handbag, tickets to sporting events, vacations, the latest electronic gadget, and high speed Internet. Everything in the “wants” bucket is optional. You can work out at home instead of going to the gym, cook instead of eating out, or watch sports on TV instead of buying tickets to the game.
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This category also includes those upgrade decisions you make, such as choosing a more expensive steak over a less expensive hamburger, buying a Mercedes instead of a less expensive Honda, or choosing between watching TV using a free antenna or spending money to watch cable TV. Basically, wants are all those little extras you spend money on that make life more enjoyable and entertaining.
20%: Savings
Finally, try to allocate 20% of your net income to saving and investing. This includes adding money to an emergency fund in a bank savings account, making contributions to a mutual fund IRA, and investing in the stock market. You should have at least three months of emergency savings on hand in case you lose your job or an unforeseen event arises. After that, focus on retirement and other financial goals down the road.
If emergency funds are ever used, the first allocation of additional income should be to replenish the emergency fund account.Savings can also include debt payments. Although minimum payments are part of the “needs” category, any extra payment reduces the principal and future interest owed, so they are savings.
Importance of Savings
Americans are notoriously bad at saving, or following budget rules, and the nation has extremely high levels of debt. In the third quarter of 2020, Americans had $14.9 trillion in total debt, which included $756 billion in credit card debt. The personal savings rate in January 2022 was 6.4%.
The 50-20-30 budget rule is meant to help people figure out how to spend their money after taxes. Its main goal is to help people save money for emergencies and retirement. Every household should prioritize building an emergency fund in case of job loss, unexpected medical expenses, or any other unforeseen monetary cost. If an emergency fund is used, the household should focus on replenishing it.
Saving for retirement is also a critical step as you live longer and longer. You will have a comfortable retirement if you figure out how much money you will need for it and start saving for it early on.
Wrap Up | Budget Rule
The 50/20/30 budget rule is a useful tool for controlling after tax income and achieving financial objectives. Building an emergency fund should be a top priority in case of job loss, unexpected medical costs, or any other unforeseen financial costs.
As you live longer and longer, saving for retirement is also a crucial step. By adhering to the 50/20/30 budget rule, people can enjoy life without giving up the things that make them happy and have a plan for how to manage their after tax income.
FAQs
A straightforward budgeting method known as the 50/30/20 budget rule allocates after tax income into three categories: needs (50%) and wants (30%); savings (20%); and debt repayment (20%). You may prioritize your expenditure with this budgeting technique while still making sure you save and invest for the future.
You must first determine your after tax income before applying the 50/30/20 budget rule. Then, divide your income in half for requirements, thirty percent for wants, and twenty percent for savings and debt payback. Essential costs including rent, food, utilities, and transportation are considered needs. Wants consist of extraneous costs like entertainment, dining out, and shopping. Retirement, investments, and debt repayment should all be covered by savings and debt reduction.
The 50/30/20 budget rule may look something like this for a person with a $3,000 monthly after tax income:
Needs: $1,500 (50%)
Wants: $900 (30%)
Savings/Repayment of Debt: $600 (20%)
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- FiftyThirtyTwenty.com – Financial Stability in America
- Experian – Average U.S. Consumer Debt Reaches New Record in 2020
- Federal Reserve Bank of St. Louis-FRED Economic Data – Personal Saving Rate
