What is the 50/30/20 Rule?

Managing your money can be a daunting task. But doing so gives you the flexibility to achieve your goals and enjoy a more comfortable life. There’s only one question: how do you know which budget is right for you?

The 50/30/20 rule simplifies financial planning for a lot of people. As you’ll learn in the next section, this strategy involves dividing your after-tax income into three categories. Those who follow this budgeting tactic often end up paying off high-interest debt, building an emergency fund, and increasing their retirement savings.

Let’s take a closer look at the 50/30/20 strategy and how you can implement it.

How to use this budget

50% needs

What exactly do we mean by needs? Well, these are necessities you can’t live without, such as a home, food, and transportation to get you to and from work. You also can’t go without utilities or health insurance, including any prescribed medications.

Then there’s revolving debt that comes around every month or several times a year. We’re talking about student loans, personal loans, car loans, and car insurance. Minimum credit card payments would fall into this category, as well.

The above expenses can sound intimidating, especially when lumped together. However, the reality is that budgeting becomes a lot easier when you know how much money to set aside for essentials every month.

Say that you make $3,000 a month after taxes. Per the 50/30/20 rule, you should spend no more than $1,500 on necessities. If that’s not possible for whatever reason, you might want to look for ways to increase your income and decrease your spending in the next category.  

30% wants

Any sound budget includes room for fun. Whether it’s a hobby, a night out with friends, or travel, we all need to plan for the occasional splurge. Remember that ‘wants’ are always things you can live without — even that Netflix subscription or gym membership.

Now, let’s revisit the above example where your after-tax pay is $3,000 a month. Is it in your best interest to spend $900 on discretionary items? Probably not.

You may realize after crunching the numbers that you need to allocate more of your funds toward essentials. Perhaps you’re living in a higher-cost area, and your rent or mortgage payment is almost $1,500 on its own. On the other hand, maybe your housing obligations are fairly cheap, but you could put additional funds toward a student loan or credit card balance.

In any case, be sure to tweak your budget accordingly. Just because a strategy tells you to allocate 30% of your take-home pay to personal spending doesn’t mean you should. Consider earmarking $100 or $200 for wants while determining what works best for you and your situation. 

20% savings

You ultimately want your money to work for you. By dedicating 20% of your after-tax income to savings, you’re building the foundation for financial success down the road.

This final category includes liquid savings accounts and investment/retirement accounts. Many experts suggest having enough cash in an emergency fund to cover three to six months of living expenses. You might even choose a more aggressive saving approach that covers an entire year if you’re out of work.

There’s ample information out there when it comes to saving for retirement. One thought you may have is how much should you have in savings by age? Do what you can to take advantage of compound interest early in your career, even if you can only manage minimal contributions for the time being.

The 50/30/20 rule states that someone earning $3,000 a month after taxes should save $600. That kind of money can have a significant impact on your short-term and long-term financial goals! See if it makes sense to split those funds into a liquid emergency fund and retirement account as you begin implementing this type of budget. 

Come up with a plan for your money

There are numerous advantages and disadvantages of the 50/30/20 budget. While it could be your ideal financial plan for the next decade, it might not be for your friend or neighbor. That said, you can never go wrong with reviewing your spending and creating an updated plan for your financial needs and goals.

At American Financing, we encourage you to check out our resources dedicated to saving for a house and creating a monthly budget. Are you interested in achieving financial independence well before your peers? Learn all about the FIRE movement and what it entails.  

Refinance for greater savings

A mortgage refinance can help you keep more of your money every month. Talk to one of our salary-based mortgage consultants and see how you could save up to $1,000 a month!