October 27, 2020
By Rahul Iyer
There are several budgeting rules out there that are geared towards helping you to achieve financial stability and ultimately financial freedom. The 50/20/30 budget is one such plan that many are using to manage their finances across America. This budgeting plan was made popular by Senator Elizabeth Warren, a Harvard bankruptcy expert. She wrote about it in her book All Your Worth: The Ultimate Lifetime Money Plan.
The 50/20/30 budgeting rule gives a very simple formula for handling your money. To follow this rule, you should spend no more than 50% of your after-tax income on your needs and 30% on your wants. The remaining 20% of your after-tax income should be put aside and saved.
Needs refer to those expenses that you must cover to sustain yourself. This category includes rent or mortgage, car payments, groceries, insurance, health care, debt obligations, and utilities. This category deals with those things that you must have. Things such as your Netflix subscription and dining out do not fall within this category.
No more than half of your after-tax income should be spent on this category. If you are currently above this in your monthly spending. You can fit into the 50/20/30 rule by readjusting your obligations over time. This will take some strategic planning and patience, but it is achievable.
This speaks to those expenses you have that you can certainly live without, but that you enjoy. This speaks to recreational activities such as going to the theatre or dinner. Things such as electronic gear that is not related to work activities, seats at a sporting event, and ultra-high-speed internet fall into this category. The primary characteristic of wants is that they are optional. While health is critical, going to the gym is also classified as a want. Why? Because you can choose to work out at home and follow a YouTube workout plan.
Wants also to speak to how you address needs. If you need housing but want a house with a large pool and a theatre, you have pushed the need into the realm of wants. Also, if you choose to purchase a Range Rover instead of a Hyundai, you have moved your transportation need to a want. All the extras or enhanced things that you desire that are not needed are considered wants. To effectively follow this rule, you must keep your spending on wants within 30% of your after-tax income.
The final aspect of the 50/20/30 rule that must be addressed is the percentage of your income that should go to savings. This is the first thing that must be done when your after-tax income hits your bank account. Financial experts have long advised people trying to build wealth to pay themselves first by putting away some money before dealing with any other expenses.
Savings include money that you place in your emergency fund and contributions to an IRA or 401(k) plan. Other investments fall within this category as well. It is important that you have at least three months of emergency saving to deal with any unexpected financial issues. When that is settled, you can begin focusing on retirement and your other financial goals.
The 50/20/30 rule can help you to get your finances in order. Adopting this pattern will ensure that you have savings. Many argue that saving is difficult; however, those who have faced difficulties in life and those who have been able to capitalize on investment opportunities will tell you that saving is critical.
It may take a while for you to adjust to this budgeting rule, but if you stick to it, you can achieve it.