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Personal budgets are an organized way to make sure all of your financial obligations are met. They make it easier to plan for the future, spend responsibly, and stay out of debt. However, there's no one way to budget or any single plan that makes sense for everybody.
Though there are many options, a strategy that divides your income into three parts using the so-called 50/30/20 rule has become a popular choice for many people as they build their financial plans.
The 50/30/20 rule is a straightforward rule of thumb that involves breaking up your spending into three distinct categories: needs, wants, and savings and debt repayment. Calculated with after-tax income, each specific category is allocated to a certain percentage of your income.
Following the rule, 50% should go toward needs, 30% toward wants, and 20% toward savings and debt. "What's nice about the system is it's simple," says Jay Zigmont, PhD, certified financial planner, and founder of Live, Learn, Plan.
With this system, needs are often the bare minimum for survival: food, shelter, health care, basic clothing, and other items of this nature. "I really think of that as your core cost of living," says Frank McLaughlin, a wealth advisor and CFP at Merriman. "They're those things that you could not live without," Often, it takes a critical and honest attitude toward spending to figure out what truly belongs in this category.
Following the 50/30/20 rule, no more than 50% of your after tax income should go towards this category. If your "needs" spending is accounting for more than half of your income, the idea of the system is that you cut back or adjust your lifestyle until you're under that threshold.
Wants are things you don't need, but they make you happy and your life more enjoyable. Anything from eating out to concerts, events, leisurely shopping, home upgrades, or vacations could fall into this category. It's things you can live without, but that you'd prefer not to. Following the 50/30/20 rule, these purchases shouldn't cost more than 30% of whatever your after-tax pay is.
The last, and smallest category, is income that should be put toward savings or debt repayment. This could mean paying down student loans, funding retirement accounts, paying off credit card debt, working toward longer-term savings goals, or building an emergency fund.
"Either way, it's increasing your net worth by either saving more or putting money toward your liabilities or areas that you owe money," McLaughlin says.
Sen. Elizabeth Warren and her daughter, Amelia Warren Tyagi, who wrote about 50/30/20 in their book published in 2005, "All Your Worth: The Ultimate Lifetime Money Plan, are widely credited for popularizing its use in personal budgeting.
Overall, the template keeps things simple, gives a general idea of where money could go, and serves as a framework to track spending against.
"It's easy, it's well structured — because of the forced savings component — and that's why it's been popular," McLaughlin says of the reasons it's caught on so much in the last decade and a half.
If you want to implement the 50/30/20 rule into your budget, experts recommend following four simple steps.
Because the template is based on after-tax income, it's important to know what this number is. For most people, the easiest way to do this will be through their pay stubs. Part of the reason it's important to look at your pay stub, and not just the amount deposited into your account, is because you'll want to make note of any contributions that are going to a retirement account or other savings plan.
"That would be considered part of the 20% into savings, so you don't want to shortchange yourself or discredit all the work that you're doing," McLaughlin explains.
Next, you'll want to calculate 50%, 30%, and 20% of your net pay to determine how much to spend in each category. To do this, multiply your after-tax pay by 0.5, 0.3, and 0.2, respectively. "Those will give you the numbers that you can roughly try to squeeze things into for those different buckets," McLaughlin says.
Once you know how much each bucket should account for in theory, take a look at where your spending is actually at in practice. Going through the last few months of your bank statements and categorizing each purchase is a good way to do this.
Knowing how much you're currently spending on your wants, needs, and savings and debt will help you determine if you'll need to cut back or adjust in any areas.
To fully implement the 50/30/20 rule, you have to track your monthly spending to make sure you're staying below your category thresholds. According to McLaughlin, this is often one of the most difficult parts of the budget. Because it can be tedious, it may discourage some potential users. A budget-tracking app is one way to make the process simpler, but pencil and paper or personal spreadsheets can also help you keep track of your spending.
Though the 50/30/20 rule can be a useful starting point, it's not always the best choice for everyone. For example, retirees may not be saving 20%, or any money at all, once they stop working. It could also be difficult to implement for those who experience irregular pay month to month or year to year — like contract workers or people who work mainly on commission.
"Not everyone is going to fit neatly into these buckets," McLaughlin says.
In some circumstances, the 50/30/20 rule just may not be possible. If you make less money, housing alone could take up half of your pay. Some people have loans that already total more than 20% before evening thinking about savings.
The rule also doesn't account for interest, inflation, or any other factors outside of spending categories. If you've got credit card debt with a high interest rate, more times than not it makes more sense to pay that down as quickly as possible before spending 30% of your income on wants.
"It's going to work best for people that have enough money and low enough debt to make it work," says Zigmont. For people who don't have any debt or low-interest, "good" debt, the rule might make sense. It could also be a good starting template for anyone who is brand new to budgeting and looking for a simple template.
"The budget is good about getting you to actually work on a budget," Zigmont says. "If it works out that it's 60/20/20 that's fine, at least you're using a budget. That's what's important."
