The 50/30/20 rule of thumb is a way to allocate your budget according to three categories: needs, wants, and financial goals. It’s not a hard-and-fast rule but rather a rough guideline to help you build a financially sound budget. To better understand how to apply the rule, we’ll look at its background, how it works, and its limitations, and we'll go through an example. In other words, we’ll show you how and why to set up a budget using the 50/30/20 rule of thumb yourself. Key Takeaways
- The 50/30/20 rule of thumb is a guideline for allocating your budget accordingly: 50% to "needs," 30% to "wants," and 20% to your financial goals.
- The rule was popularized in a book by Elizabeth Warren and her daughter, Amelia Warren Tyagi.
- Your percentages may need to be adjusted based on your personal circumstances.
- It’s only a rule for how to plan your budget; it doesn’t actually track your budget for you.
What is the 50/30/20 Rule of Thumb
The 50/30/20 rule of thumb is a set of easy guidelines for how to plan your budget. Using them, you allocate your after-tax income to the following categories:50% is allocated to needs
Needs are what you can’t live without, or at least not very easily. They include things like:- Rent
- Groceries
- utilities, such as electricity, water, and sewer service.
30% to Wishes
Wants are what you desire but don’t actually need in order to survive. They might include:- Hobbies
- Vacations
- Dining out
- Digital and streaming services like Netflix and Hulu
20% to Financial Goals
This category covers two main areas:- All savings, such as retirement contributions, saving for a house, and setting money aside
- Debt payments
Where Does the 50/30/20 Rule of Thumb Come From
The 50/30/20 rule was popularized by Senator Elizabeth Warren (a Harvard law professor when she coined the term) and her daughter, Amelia Warren Tyagi, in the book All Your Worth: The Ultimate Lifetime Money Plan. It was designed as a rough rule of thumb for working-class families to plan their spending in order to prepare for the future and unforeseen circumstances.How to Use the 50/30/20 Rule of Thumb for Budgeting
Most people save too little and unknowingly spend too much. The 50/30/20 rule of thumb is a way to become aware of your financial habits and limit overspending and under-saving. By spending less on the things that don’t matter that much to you, you can save more for the things that do. Here’s how it works:- Calculate your monthly income: Add up how much you receive in your bank account each month. If you have a workplace retirement plan, find out how much is withheld, and add that amount back in with your take-home pay. If you pay estimated taxes, reduce your monthly income amount accordingly.
- Calculate a spending threshold for each category: Multiply your take-home pay by 0.50 (for needs), 0.30 (for wants), and 0.20 (for financial goals) to see how much you should ideally spend in each category.
- Plan your budget around these numbers: Think of these three categories as "buckets" that you can fill with monthly expenses. List and tally your monthly expenses under the category that each falls into and see whether you’re spending less than the monthly targets you established in the prior step.
- Follow your budget: Track your expenses each month, and make changes where needed, in order to stick to your spending thresholds going forward.
An Example of the 50/30/20 Rule of Thumb
Here’s an example using the steps above:- Calculate your monthly income: Let’s say you and your spouse have a total of $4,787 deposited into your bank account each month from your jobs. You both check your pay stubs and see that a total of $532 was taken out for 401(k) contributions. This means that, together, your monthly income is $5,319 ($4,787 + $532).
- Calculate a spending threshold for each category: Based on the 50/30/20 rule, the amount you should allocate to "needs" is $2,659 ($5,319 x 0.50). The amount you should allocate to "wants" is $1,596 ($5,319 x 0.30). The amount you should allocate to financial goals is $1,064 ($5,319 x 0.20). Since you’ve already contributed $532 to your 401(k), use the remaining $532 to pay down debt or save for other financial goals.
- Plan your budget around these numbers: Go through your budget to either plan out your spending or see how well it is already aligned with these targets.
Why Does the 50/30/20 Rule of Thumb Generally Work
Figuring out your finances is confusing, and it’s often hard to know where to start. That’s one reason the 50/30/20 rule of thumb works so well: It’s an easy way to get a handle on something that can otherwise be intimidating. Even if you don’t take it any further by tracking how well you stick to these targets, it’s still a good way to take your financial pulse.A Grain of Salt
Like any rule of thumb, it’s a good idea to take the 50/30/20 rule of thumb with a grain of salt.Gray Areas Are Possible
It’s sometimes hard to sort out your spending according to three categories. Everyone needs to eat, for example, but some groceries fall into the want category (like sugary sodas and unhealthy snacks).It Can Be Difficult for Low-Income People
If you’re earning just enough to make ends meet, you may struggle to save 20% of your income regardless of how you live, especially if you’re supporting a family.Savings Might Not Be Enough
On the flip side, if you have big goals like retiring early or buying a house in a high-income area, 20% might not be enough. For example, the average home price of a house in San Francisco was more than $1.6 million in June 2022.1.You would need to save, on average, $320,000 to afford a 20% down payment there.You Still Need to Track Your Budget
The 50/30/20 budget rule is only one piece of the budgeting puzzle. It’s good to shoot for these percentages, but unless you track your spending, you’ll never know whether you’re actually hitting them.The 50/30/20 Rule of Thumb vs. Other Budgeting Methods
The 50/30/20 rule of thumb isn’t the only game in town. Here are a few other budgeting techniques that might work better for you:- The 80/20 Rule: With this method, you immediately set aside 20% of your income for savings. The other 80% is yours to spend on whatever you want, with no tracking involved.
- The 70/20/10 Rule: This rule is similar to the 50/30/20 rule of thumb, but you instead parse out your budget as follows: 70% goes to living expenses, 20% to debt payments, and 10% to savings.
Frequently Asked Questions (FAQs)
How does tithing figure into the 50/30/20 rule? As with any rule of thumb, you'll need to adjust it to fit your specific circumstances. When it comes to tithing or any other religious expense, individuals can decide for themselves whether that's something they "want" or "need." Where does credit card debt go in the 50/30/20 rule? Paying down debt is considered a financial goal. That means you should allocate 20% of your budget toward some combination of paying down debt and saving for the future. How much of your paycheck should you spend on the 50/30/20 rule The 50/30/20 rule doesn't specify how much of each paycheck you should spend. The percentage of your paycheck that you spend or save largely depends on the 20% financial goal category. If your main financial goal is to reduce debt, you'll be spending more of your paycheck on that. If your main financial goal is to save up an emergency fund, then you'll be saving more of your paycheck.