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What is the 50/30/20 Budgeting Rule and How it Works

The 50/30/20 rule is the most successful financial budgeting method available. The rule is simple, spend 50% of your income on needs, 30% of it on wants, and 20% of it on long-term financial goals such as savings or paying down debt. If you have found yourself with credit card debt, or are struggling to pay bills due to a change in job or illness, then creating a financial budget based on the 50/30/20 rule will make sure you stay on track.

Developed by Elizabeth Warren in her book All Your Worth: The Ultimate Lifetime Money Plan, the budget is designed to perfectly balance your life's finances while focusing on your well-being. This work is continued in the book co-written with her daughter Amelia Warren Tyagi named The Two-Income Trap.

Here's a detailed guide on how to split your finances using the 50/30/20 rule.

Part 1: Preparing Your Planner

The first thing you will need to do is decide whether to use an online spreadsheet or a pen and paper. A spreadsheet is the most effective way to make adjustments easily, but many people prefer pen and paper's psychological familiarity.

For simplicity, separate it into three categories. These are 50% needs, 30% wants, and 20% savings. We will describe these in detail below, but it's best to keep it simple at first, no matter how analytical your end tracker will be. Otherwise, you might find yourself overspending in a different area.

And remember, it's important to keep an open mind throughout the process. The rule is there to guide you, not direct you. The best approach is to take it step by step. And make sure you can effectively manage your plan before moving forward.

Know Your Pre and Post-Tax Income

Once you have a spreadsheet or a list in place, you need to use a calculator to work out how to distribute your allowances. All you need is your after-tax income, including any extra monthly income you receive from investments or side-hustles. The easiest way to do this is to check your payslips or bank statements and see what's coming in.

If your income isn't regular, such as earning a commission or being self-employed, then it is advised only to fill in your minimum income. That way, you will avoid any financial stress from not hitting targets for one month.

50% Needs

Now you have the template and a basic overview of your budget, you must write down all your essential living expenses. For example, rent or mortgage payments, utility bills, and taxes will come under this bracket.

You will see some areas can get a little ambiguous. But the great thing about this planner is you can adapt it to suit your own personal finances.

For example, you might consider any legal commitment a need, such as paying off a student loan or credit card. In this case, it's sensible to write down the minimum payment as that is your legal requirement. You can look at how to manage your debt repayment later.

30% Wants

Once you've listed all the needs, it's time to look at the wants. This is probably the hardest category to analyze because while it's easy to accept that a car payment is a need for some, it may be a want for others. You will find yourself questioning whether certain expenses belong to needs or wants throughout the process.

But don't see that as a negative. Questioning your spending habits in this way is exactly the reason behind planning a great budget, so you know for the future what allowance you should provide for each.

For now, stick to writing down your current expenses. At this stage, it's more important to visualize your existing expenses.

20% Savings

Now you have categorized your needs and wants. You can write down your savings. The idea behind 20% savings is that you build up an emergency fund. That way, if you ever end up in financial difficulty in the future, you will have a buffer to fall back on.

That said, if you are in debt or want to take credit in the future, it's a good idea to research your credit score to find out how you can improve it. That way, you are more likely to be accepted for lower interest rates, which is especially good for shifting debt from high interest to a low-interest loan or card.

If you aren't currently putting anything aside, that's okay. The plan will help you work out how much you need to save into a savings account, ira, or rainy day fund. Moving on to the next steps will help you work out what path is best for you to take.

Part 2: Analyze Your Spending

Now you can work on your financial goals and prioritize those that are more urgent than others.

Goals depend entirely on your personal situation. The chances are you have a goal in mind already, but you need to look at the list you have just written and ask yourself, is it the right goal? For example, if you have high debt levels but want to start saving for a deposit for a house, you may need to realign the allocation of your goals based on the 50 30 20 rule.

Further, consider health insurance. Healthcare can be very costly, and only a few countries in the world are fortunate enough to have free healthcare paid through taxes. You can plan your finances in any way you like, but if you aren't healthy, you may find yourself unable to reach your goals in the long-term.

50% Needs

The vast majority of people find this the easiest category to evaluate. If you can't afford to live, drastic changes must be made. That can either mean earning more money, cutting spends on non-essentials, or reducing your living costs.

Sort your needs from highest spend to lowest. Then scrutinize that expense and ask yourself how you can reduce it. In some cases, such as social security and tax, especially if you receive a gross income and do your own taxes, that won't be possible.

In many cases, however, this is easy. For utility bills, shop around and see if you are on the cheapest tariff. Or, if you are a taxi driver and your car is a need, shop around for the cheapest insurance premiums.

Once you have reduced your needs, you can re-assess. If you are under 50%, that's great news. If you are over 50% and can't reduce them any further, then it's worth considering whether you can ask for a pay raise at work or change. If not, then it may be time to consider cutting more expenses and increasing your take-home pay.

30% Wants

The next step is to look at your wants. Again, sort from highest monthly cost to lowest, but this time, focus on your overall spending first. This doesn't always mean cutting a want out of your life. Like the needs section, you can do your research and see if there is a cheaper way of keeping your wants in your life.

For example, can you reduce your car insurance and gas costs by walking to the shops once a week to lower your mileage. And if you end up walking three times a week, you might find gym memberships are a thing of the past.

It's common for people using the 50 30 20 plan to find themselves cutting out payments they thought they needed but didn't, especially in examples like the one above.

20% Savings

If you aren't putting anything aside, now is the time to consider your end goals, both short-term and long-term, seriously. If you are looking to buy a house in three years, how much down payment will you need? And how much do you need to save per month to get there?

Finding a bank account that provides good interest rates can be hard to come by. However, it is also worth taking your debt payments into account. This also works the other way round.

For example, if the highest-earning bank account pays 3% interest, but your credit card is 20% interest, then consider paying off your credit card first and increase your monthly payments to do so. You may think you are saving, but instead, it will save you money to reduce interest.

Part 3: Rewrite Your Plan

It's time to go back over again and, on a new sheet, set yourself some savings goals and outline where you can reduce unnecessary spending, and in some cases, where you might need to spend a little extra.

This time, take the knowledge you gained from analyzing your finances and link this to your goals. This part of the process will help you understand the steps needed to reach those goals and whether they are achievable or revised.

Let's remember. This isn't all about saving money. If you need a new budget laptop for work because your old one is on it's way out, and you have spending room for $20 a month, then that's why it's there! Plus, you will find yourself revisiting each section several times as you fine-tune the plan with more experience.

Start with Savings and Goals First

For this one, it's best to start backward. With spends, for example, you should have already got them nailed in part 2. As discussed, if they can't be brought down any lower, look at freeing up income, whether that's a pay raise or by cutting more of your wants out short-term.

Distribute your 20% savings into the categories you need. You might want to split 10% retirement savings, 5% ira, and 5% emergency fund. Your primary goal is to save for the future, so that's the best place to start.

You may have other savings goals in mind. Plus, if your primary goal is to become debt-free, most of your focus on savings should be paying down that debt. That way, you create minimal disruption as your needs, and wants are focused elsewhere.

Work on What You Want and Need

Then, once you know how much you need to invest, take your life goals for your wants, and write them down. If you feel aspirational, you can always write a separate goals list. If buying a new car takes you over by $100 on your wants, why not use that as a goal to inspire you to get a $300 per month promotion at work!

And there's a good chance you'll see more money coming in as well. With a happier, more positive outlook on your financial situation, you'll find that, as long as your needs are covered, you may actually want less in life, and that frees up more money to save for the future.

Plus, you'll end up performing better at work because morale will improve, and by the end of it, you'll more likely get the pay raise you deserve.

Making the 50/30/20 rule your own

The 50 30 20 rule has proven itself time and time again to be the perfect starting point for anyone looking to turn their finances around. While the plan guides you, it is only a rule of thumb after all. If you take pleasure in nature, feel free to reduce your wants and increase your needs allowances, only if it's right for you. If not, stick to the plan.

The warranty of having a contingency pot of money in place is invaluable and will ultimately lead to a happier, less stressful lifestyle. Do remember, however, that we advise seeking in-depth financial advice as a disclaimer, especially if you are struggling with debt issues.

Keep browsing for more advice on how to improve the six vital signs of financial health.

About the Author

Harvest helps increase the net worth of the 99% through artificial intelligence and financial automation. To date, Harvest has refunded over $2M in bank fees and interest charges to its members with the ultimate goal of increasing the net worth of everyday Americans by $1 trillion by 2030. Our platform starts with providing immediate relief through bank fee and interest charge refunds, orients a member's financial health with our proprietary PRO Index, and keeps track of net worth over time aided by our suite of financial tools. Check out our 8-step guide on "How to Build Wealth from Nothing" to get started on increasing your net worth.

Disclaimer: Harvest is not providing financial advice. The content presented does not reflect the view of the Issuing Banks and is presented for general education and informational purposes only. Please consult with a qualified professional for financial advice.