The 50/30/20 Rule: How To Budget Your Money

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Budgets are at the core of every solid financial plan for two reasons:

  • They help to track spending, which tells you everywhere your money goes, and;
  • They prioritize the most critical expenses, which ensures smooth financial sailing.

In this way, budgets foster healthy financial habits like saving and investing because they point out and cut wastage, enabling you to direct your money towards things that build wealth over time.

Of the numerous ways to budget, the 50-30-20 rule stands out because of its simplicity. It tells you exactly how much to spend on all essential categories, leaving no room for confusion.

Let’s explore how it works in more detail.

What is the 50/30/20 Rule?

The 50/30/20 Rule

The 50/30/20 rule is a budgeting approach that splits your after-tax income into 3 essential categories: 50% for needs, 30% for wants, and 20% for savings or debt.

With this straightforward guideline, you can easily examine your expenses and categorize them accordingly. But how do you determine if something is a necessity or an option? What separates a need from a want?

Here’s how the 3 categories work:

50% for needs

This first category covers all your necessities - everything you can’t go without. Things like your rent, food, health coverage, and all other crucial essentials like your water/electricity bills.

What’s important here is to get clear on what qualifies as a ‘need’ and what doesn’t. For example, while ‘food’ counts as a basic need, eating out certainly doesn’t. And so expenses like that don’t get categorized under ‘Needs’.

For something to qualify as a need, it should be:

  • Necessary – like a basic need. For example, your rent and grocery budget.
  • A recurring and predictable expense – for instance, you have to keep paying your water/ electricity bill each month, and you have a good idea of how much you pay each time.

Defining your needs will clarify things so that you don’t end up including unnecessary stuff in this allocation and make it go over 50%.

30% for your wants

What qualifies as a ‘want’?

The simple answer: anything that isn’t a need. If it isn’t essential enough to include in the first category, then it’s not necessary, which makes it a ‘want’.

Wants are the things you enjoy or that make your life more comfortable, but you can do without. Consider things like your Netflix bill, your eating-out budget, your brand-new clothes budget, etc. While they make life a little more interesting, they aren’t essential.

But isn’t 30% too much to spend on enjoying yourself?

That depends on who you ask. If your needs exceed 50% of your expenses, then it follows that this bucket will be the first you reduce to accommodate that extra. If you wish to save more, again, you can also shave off some percentage from this bucket.

A lot of expenses in this category are open to interpretation. Its main purpose is to inject some fun into your spending so that you can stick to your budget.

20% goes to savings

This last category is straightforward. It also happens to be the most important. And that’s because it goes to your financial security.

For beginners, this allocation goes to two key priorities: building your emergency fund and paying your debts.

The immediate concern here should be to build an emergency fund. It’s important because financial emergencies will always crop up and going into debt to cover emergency costs will only set you back.

A well-kept fund will keep you prepared for such instances.

Once that’s done, you can focus on other saving and investing goals. This part is where you’ll start thinking about growing your wealth long-term.

Advantages of the 50/30/20 rule

The 50/30/20 rule stands out because it has some advantages over other budgeting techniques. These include:

  • Simplicity and ease of use - it contains only three simple categories that apply to everyone regardless of their income or expenses. Users need only clarify what falls under what category and then adjust their budgets accordingly.
  • Addresses both ‘work’ and ‘play’ - unlike other budgets that stress the value of financial tightness and leave nothing for enjoyment, the 50/30/20 rule features a ‘wants’ category that pays attention to such needs.
  • It fosters wealth-building habits - adopted consistently, the 50/30/20 rule leads to a reduction in debt, an increase in savings, and the adoption of investing. The 20% that’s secured for such purposes keeps adding up over time, leading to greater financial security.

How to adopt the 50/30/20 budget rule

Regardless of what they make, anyone can arrange and adjust their finances to fit this rule. All that’s needed is awareness, which means that you’ll have to keep an eye on your priorities and ensure you don’t miscategorize wants as needs.

Here are five steps to help you adopt this rule effectively:

  • Determine what your after-tax income is – focus on your net income, not gross i.e. the money you receive after all standard deductions are made.
  • Track your expenditures to ascertain where your money mostly goes – Which payments have to be made each month? Which costs are predictable and recurrent? Which ones are optional and can be reduced?
  • Split your expenditures into the 3 necessary buckets be especially clear about what qualifies as a need and what qualifies as a want.
  • Revise and adjust your allocations accordingly – in case your needs take up more than 50%, or you have to allocate more than 20% to savings, this process will help you sort it out.
  • Automate your savings – being the category that secures your financial progress, you'll want to be consistent with this allocation. Automation means setting up your finances such that your savings are deducted automatically and remitted where they need to, whether that’s to your emergency or investing account.

When the 50-30-20 budget is not practical

What if your needs exceed 50% of your income? Isn’t 30% too much to spend on wants? Should you allocate more to debts and savings?

Of course, this budget rule is not clear-cut to fit into everyone’s situation.

So it’s important to tailor it to your circumstances. If your ‘needs’ take up more than 50%, then perhaps a 60-20-20 approach will suffice. Or maybe 70-15-15 will be better suited.

Take the liberty to adjust it however you need to but be crystal clear on what falls under ‘needs’ and prioritize the ‘savings’ category. By taking care of these two, everything else will fall into place.

Over to you

As we’ve seen, budgets aren’t just important as money management tools, but also as future planning tools. If at all you are going to be consistent at cultivating wealth, you’ll need one to help you stay on course and be consistent.

The 50/30/20 rule, with its simplicity, brings clarity to the planning process because it's straightforward. What do you think? Is it practical?