The 50/30/20 rule was coined by Harvard bankruptcy expert Elizabeth Warren, a U.S. Senator from Massachusetts who was named by Time Magazine as one of the 100 most influential people in the world. With credentials like that it’s pretty safe to presume she knows what she’s talking about, don’t you think?
The way it works is quite simple and requires a few important details which we’ll cover at length in just a moment. The most important of those details being that you must calculate your 50, 30, 20 split after you’ve factored your taxes into the budget you’re working with as this meant to be used with your net-income meaning post-tax. It also assumes that you’ve already taken the time to come up with a reasonable budget which you’re currently following.
The split looks like this:
- 50% goes to Needs
- 30% goes to Wants
- 20% goes to Savings
Calculating your After-Taxes Income
This step is fairly straightforward for those of us who are employees of another business entity besides ourselves, in other words you’re not self employed. All those little expenses are already taken from your pay and the deductions are typically stated right there on your pay-stub. For the sake of brevity here is a quick list of what to expect will already be deducted from your paychecks:
- Social Security
If you have other fees taken from your paychecks such as health care, retirement contributions or basically anything else outside of those base-three listed just above then add them back into your “after taxes income” figure as they will be calculated in elsewhere.
Self Employed Income
If you are self employed then your calculations will simply be your gross-income less your business expenses. Things like the cost of computers, office furniture, airfare to business related conferences and the like can and should all be subtracted from your gross total. Be sure to also reduce the amount you’ve set aside to pay your quarterly tax bill as that’s part of your expenses.
Sticking To 50% To Cover Needs
This is where things could get a bit tricky for some of us. It’s essential to squeeze all of your “needs” into just half of your after-tax income each month. It’s up to you to determine what are needs, typically things like groceries, housing and utilities fall into this category. Car payments and insurance can often be added into that total as well.
Typically any payments you can afford to miss or completely go without while feeling only minimal discomfort or none at all will be classified as wants. Stuff like cable and internet bills, back to school clothing for the kids, splurging on large data plans for the smart phones and etc, if it can be cut back or cut out completely without affecting your quality of life in any major way deems it a want instead of a need and thus it does not fit into this category.
A quick note on credit card payments…
If you can’t forego a minimum payment on a credit card bill then you may consider it a need as skipping on this will negatively impact your credit score which is counterintuitive to the benefits of the 50, 30, 20 rule. Meanwhile, if you typically pay more than the minimum requirement each month in order to keep a manageable balance then that minimum amount is a need while the rest of the amount will be classified under the savings & debt category which we’ll discuss a bit later on.
Keeping Wants To Just 30% Of Expenses
Don’t let the name fool you, ‘wants’ don’t count for everything under the sun but instead they are expenses you could consider as lesser-needs. Things like high speed internet, large data plans on cell phones, those expensive name brand snacks at the supermarket as well as clothing. Additionally you can toss cosmetics, car detailing (anything not essential to maintenance) and even running your central air at precisely the temperature you want when you could be running it just a few degrees lower in an effort to shave a few dollars off your electric bill each month.
This is the part that gets tricky for some as it is really going to require you to sit down with your budget and figure out what are your true needs and what falls under the wants category. You don’t have to go crazy with the cutbacks but it’s important to fit these “wants” to just 30% of your allowed budget after taxes… there is still 20% left which will need to go into savings and debt payments.
Saving 20% Each Month + Emergencies & Debt
We’ve made it to the home stretch, this is where the rest of your budget falls and it’s also where that extra money you’ve been paying your credit card bills with goes. If you’ve been paying those statements off at a rate higher than the minimum then any amount which is over that bare min. payment goes right here under the savings & debt category.
This also carries over to other expenses which you simply must meet each month less you encounter penalties and fees. Things such as your mortgage, car loan and other payments which give you an option of a minimum payment. That minimum will be classified under the ‘needs’ category while the remainder of what you might pay will fall under your ‘savings & debt’ expenses. It’s important to set aside this 20% for things like emergency funds, paying off debts, saving money and of course planning for your retirement.
Wrapping It All Up
We live in the real world and although it’s perfectly understandable that you may not be able to stick to these percentages of your net-income each month it’s going to help you in the long run if you can adhere to it as closely as possible.
“Money problems” constantly plague us and a huge part of the root problem comes down to poor money management, that’s what this financial tip helps to alleviate.