Most people feel frustrated when taking out money for emergency fund from a tight budget. It can be daunting when you have no idea what to do. Once you figure out the perfect way, you can make adequate changes and improve your financial status with a substantial success rate.
One such way to develop a budget is the 50/30/20 Rule. It seems like crazy numbers, but trust me, it can help you create a sound financial status that will help you even after retirement. How? Let me tell you in detail.
What Is Meant By 50/30/20 Rule?
The 50-30-20 rule basically means splitting your after-tax income into three spending categories: 50% goes to needs, 30% to wants, and 20% to savings. This straightforward and intuitive rule can help you draw up a practical budget that you can stick to over time to meet your long-term financial goals.
50%: Needs
Needs are those bills you must pay and the things important for survival. Half of your after-tax income should be all you need to cover those obligations and basic needs.
Consider cutting down on wants or trying to downsize your lifestyle if you spend more than 50 percent on your needs. This might mean considering moving to a smaller home or buying a more modest car. Additionally, carpooling to work or cooking at home are more effective cost-cutting solutions. Examples of needs include but are not just limited to:
- Rent or mortgage payments
- Car payments
- Insurance and health care
- Minimum debt payments
- Utilities
- Groceries
30%: Wants
Wants are the things or expenses you spend money on that are not absolutely vital. You can watch sports on TV instead of getting tickets to the game or working out at home instead of going to the gym.
This category also includes your upgrade decisions, such as opting for a costlier steak instead of a less expensive hamburger, or buying a Mercedes instead of a more economical Honda, or selecting between watching TV using a free antenna or watching expensive cable TV. Wants are all those extra expenses you spend money on that make life more entertaining and enjoyable. Examples of wants include but are not limited to:
- The latest gadgets, especially an upgrade over the fully functioning model you already have
- Tickets to sporting events
- Ultra-high-speed internet beyond your streaming needs
- Vacations or other non-essential travel
- Unnecessary accessories or shopping for clothing like handbags or jewelry
20%: Savings
Try to allocate 20 percent of your net income to investments and savings. You should have at least three months of emergency savings in case you suddenly lose your job or an unforeseen event occurs. Focus on retirement and meeting more long-term financial goals after that. Some of the top examples of savings can include:
- Creating an emergency fund in the bank
- Setting aside some funds to buy physical property for long-term holding
- Making debt repayments or credit card bills beyond minimum payments
- Making IRA contributions to a mutual fund account
If any of these funds are ever used, the first allocation of additional income should replenish your emergency funding account.
Why Do You Need Savings
Let’s be honest: Americans are notoriously bad at saving. The U.S. has exceptionally high levels of debt (whether it’s bank loans, credit cards, or student loans). The average personal savings rate for individuals in the United States was around 3.4% in June 2024.
The 50-30-20 rule allows individuals to manage their after-tax income, primarily so they have funds for emergencies and retirement savings. Every individual at home should create an emergency fund in case of unexpected medical expenses, job loss, or any other unfortunate monetary cost. If an emergency fund is used for some reason, the household should focus on replenishing it wisely.
Saving for retirement is also critical because people are living longer. Calculating how much you think you will need for retirement at a young age and then working toward that passion can enable you to ensure a comfortable retirement.
Multiple Benefits of the 50-30-20 Budget Rule
The 50-30-20 rule can help individuals to achieve financial prosperity in numerous ways. The potential advantages of these guidelines are as follows.
- Ease of Use
The 50-30-20 rule offers a simple framework for budgeting. It’s easy to understand and apply. You can distribute your net income immediately without the need for intricate or complex calculations. Even the least financially aware individual can follow these rules pretty easily.
- Better Money Management
You can smartly manage your money in a balanced way by using a budget. You can make sure that your necessary costs are covered. Additionally, you have money for discretionary spending, and you are actively saving for the future. You can save for current and future requirements this way and still have a little fun with your finances in your own way.
- Prioritization of Vital Expenses
By prioritizing these basics, you can cover your basic needs without going over budget or taking on too much debt. These rules demand that half of your budget goes toward needs, so this plan helps ensure your essentials are more likely to be properly met.
- Emphasis on Savings Goals
You can outfit an emergency fund, pay off debt, invest, prepare for retirement, or pursue other monetary goals by dedicating 20% of your income to savings. By consistently saving this amount, you will establish robust financial practices and build a healthy safety net for unforeseen costs or future goals.
- Long-Term Financial Security
You can prioritize your financial future by continuously setting aside 20% of your salary. This expenditure to savings can help you accumulate money, meet long-term financial objectives, and give yourself and your family a sense of security in either the short or long term.
The 50-30-20 rule allows anyone to use these proportions regardless of income. However, you may have to adjust the percentages if your income is low or you live in an area with a high cost of living.
Simple Steps To Adopt 50-30-20 Budget Rule
No single method of budget tracking will work for everyone, but these tips on adopting a 50-30-20 budget are relevant to nearly everyone.
- Track Your Expenses
Track your expenses for a month or two to better stipulate your spending habits. Assess your spending to count how well or poorly it follows the 50-30-20 breakdown by breaking down what you spend into needs, wants, and savings. This will help you better learn how far off from budget you will be when you start.
The only way you’ll know if you’re succeeding at adhering to this eccentric budget is by tracking your actual spending. This can be done relatively easily using spreadsheet techniques such as Microsoft Excel.
- Understand Your Income
The start of the 50-30-20 budget is rooted in a firm grasp of your income. Remember that your gross income may differ greatly from your net income. Gross income (GS) is the amount before federal and state income taxes are deducted. It’s not what you can take home and spend.
Understanding your earnings and what hits your bank account each pay period will enable you to establish the correct budget for the three categories.
- Identify Your Critical Costs
Critical costs include rent or mortgage payments, transportation expenses, utilities, groceries, insurance premiums, and debt repayments. These costs are key for your daily living patterns. They may take up the largest portion of your budget, so it’s essential to be most mindful of this group. They must be paid, so you probably have the least amount of flexibility with them after you have committed to them.
Signing up in a rental agreement at a fixed cost usually requires a 6-month to 12-month lease contract.
- Automate Your Savings
Saving will be easier if you automate the process. Make sure to set up monthly automatic payments from your checking bank account to your investment or savings accounts. This promises that your funds will increase steadily without requiring manual labor. If you carry a lighter administrative burden, you may find it easier to review your budget periodically to make sure it aligns with your lifestyle and financial goals.
- Maintain Consistency
Opting for a 50-30-20 budget successfully will also require maintaining consistency. Stick to your spending strategy strictly over time and stop the urge to go over budget or depart from your percentage allocations. This spending strategy is often successful when you have clear guidelines that can be benefitted every month. Remember to reset your spending limits monthly and maintain consistency from one month to the next.
Example of the 50-30-20 Budget Rule
Let’s say that Adam recently graduated from college and started his first full-time job. He wants to have good financial habits from the start and has heard about the 50-30-20 budget rule. Here, he decides to set up a 50-30-20 budget.
He starts by tracking his monthly expenses using a budgeting app that automatically categorizes them into needs, wants, and savings. He also calculates his monthly after-tax income, which amounts to $3,500. This will be his basis for allocating his budget according to the 50-30-20 rule.
After analyzing his tracked expenses, Adam realizes that his essential expenses, such as rent, transportation, utilities, groceries, and student loan payments, add up to approximately $1,750 per month. Then, he allocates exactly 50% of their income, or $1,750, to cover these requirements.
He then allocates $1,050 to discretionary items and $700 each month to saving and retirement. Adam set up an automatic transfer from his checking account to his savings account to occur on each payday.
Six months later, Adam is promoted. His income has changed (increased to a great extent). So, he reevaluated each budget amount, reviewed his overall budget, and made adjustments as required. He also realized that his transportation expenses were higher than expected, so he decided to begin carpooling with a colleague to cut costs.
Adam remains consistent and disciplined with his budgeting practice. He prioritizes financial well-being and regularly evaluates his progress toward his goals. So continues to adjust his budget to reflect changes in his income and priorities as he progresses in his career. He has taken steps to not only meet his current needs but to have sufficient funds available for his future as well.
More resources are available to help support your financial future if you’re still young but plan to retire.
The Bottom Line
We understand that saving is difficult, plus life often throws unexpected expenses at us from time to time. The 50-30-20 rule can provide you with a plan for managing your after-tax income. If you find that your expenditures on wants are more than 30%, you can easily find ways to reduce extra expenses and direct funds to more important areas, like emergency funds and retirement.
Life should be enjoyed, and it isn’t recommended to live like a Spartan. However, having a solid plan and sticking to it will help you cover all your expenses and save for retirement while enjoying every perk and recreation that makes you happy.