Budgeting 101: Everything You Need To Know About The 50/30/20 Budgeting Rule

By | 2019-04-29T15:57:30+00:00 29 April, 2019|Uncategorized|

The 50/30/20 budgeting rule was formulated by former Harvard professor and U.S. senator from Massachusetts Elizabeth Warren in order to give people specific guidelines as to how they should allocate their disposable income. The disposable income is the income that is available to you after you have paid your taxes.

After your taxes have been deducted from your pay, you are left with an amount of X that you can either use to consume or save. The 50/30/20 budgeting rule seeks to answer the question how households ideally allocate their money.

50% Of Your Income For Your Needs

You must cover your “needs”, obviously. Needs include your mortgage or rent, utilities, groceries, health insurance, and transportation. Needs are really just necessary expenses that you cannot avoid and have to accept in order to live your life. Ideally, according to the 50/30/20 budgeting rule you spend about 50 percent of your after-tax income on your needs while allocating the remaining 50 percent to your wants and your financial priorities.

30% Of Your Income For Your Wants

Next in line are your “wants”. Wants differ significantly from your needs because you do not need them in order to survive. Classic examples include entertainment expenses, going out, shopping, dining out or buying new gadgets such as a new smart phone or a tablet. “Wants” also includes money that you spend on hobbies or vacations.

20% Of Your Income For Your Financial Priorities

The remaining 20 percent of your income should go towards building savings and/or repaying debt. Building savings is super important in order to prepare you for your retirement. 20 percent of your income may sound like a lot of money at first, but ultimately you invest in yourself which is why it is worth it.

If you have debt, repayment of debt takes priority over building savings. Your immediate priority in this category should be to repay your highest-yielding debt first and work your way down the debt hierarchy.

Flexibility

The budget allocations discussed above are rough guidelines and are not set in stone. Everyone will have different budgets, and slight budget overruns are also quite common.

Personally, I agree obviously support the idea of creating a budget, but I believe that reserving 30 percent of your income for “wants” is quite generous, and I think there is considerable potential to increase your savings rate here. If you are prepared to make more sacrifices in your life in terms of delaying gratification, you could try to increase your savings rate to 25 or 30 percent IF you are willing to push it.

Takeaway

The 50/30/20 rule is a good starting point for people that are just starting out and don’t have much budgeting experience yet. The guidelines make sense for starters and provide a solid foundation for you in order to learn to deal with money more responsibly. As you go along, you can easily tweak your budget a little bit here and there, but I would recommend you place more emphasis on savings category in order to work more aggressively towards financial freedom.