If you’re new to budgeting, managing your money can feel frustrating and overwhelming. You’ve tried following your parents’ suggestions, and your financial advisor’s recommendations, but nothing seems to work. Your expenses are inconsistent, and your financial compass is out-of-whack. But don’t give up just yet! Follow the 50/30/20 rule (religiously), and all of your money nightmares will soon be over.
What is the 50/30/20 rule? And how does it work?
Elizabeth Warren, Harvard bankruptcy expert (and 2020 presidential candidate), coined the term “50/30/20 rule” with daughter Amelia Warren Tyagi, when co-writing their guide to personal finance. Warren defines the 50/30/20 rule as an easy way to budget your money. The way it works is that it divides your monthly income into three expense categories: needs, wants, and savings. Each category uses up to 50%, 30%, and 20% of your monthly income, respectively. Easy enough, right? Now, let’s get into the nitty-gritty, and teach you how to use Warren’s golden rule of finance.
Step 1: Determine how much money you can truly spend
Before mapping out the 50/30/20 rule, figure out what your actual income is. This step requires a little bit of math – but no worries, it’s as easy as 1,2,3! To get started, look for your gross income – the pre-tax salary on your employment contract. Once you have it, determine your actual income by deducting taxes and other expenses including healthcare, Medicare, social security etc. This number will constitute your net income, which you will use for the 50/30/20 rule.
Amelia has a gross income of $5000/month. After subtracting taxes and other expenses, Amelia is left with a net income of $3750. Now that she knows how much money she makes, she can think about how to spend it.
Step 2: Spend 50% on your needs
Take a look at all your financial responsibilities and needs – rent, utilities, groceries, health/wellness, healthcare, transportation, and any other essentials. At most, they should make up 50% of your take-home income. If you’re struggling with what to include in this category, think of all the goods and services you can’t really live without.
Amelia reserves 50% of her net income for her needs. This means she has $1875 to spend on her rent, utilities, food, commute, wellness, and other general needs. Like most people, she almost always uses the full 50%. Bills just have to get paid!
Step 3: Limit your wants to 30%
Somehow, we all love to splurge on the unnecessary. Case in point: Did you really have to buy a that $200 sundress or spend $100 on pet toys? Probably not, but life is all about the little pleasures, too! A good way to keep your frivolities in check is to limit desire-driven buys to 30% of your net income. While 30% may seem like a lot; be careful because it tends to add up pretty quickly. This category also includes your Netflix and Hulu bills, your late night ramen order (sure, it’s food, but if you just used the groceries in your fridge, you would have saved a pretty penny), and that MOMA ticket you bought when visiting NYC. It adds up quickly, so be mindful of your spending!
Amelia allocates 30% of her net income to her wants. In other words, she has $1125 to spend on whatever her heart desires! She decides to splurge on a Lululemon workout set, and two pairs of Nike running shoes. She pays for her monthly AppleNews and Amazon prime subscriptions, and she attends a few events at the bar by her house. Finally, she splurges on a nice gift for her best friend’s birthday. All together, she ends up spending $1000.
Step 4 : Save 20%
Saving money is a huge component in reaching financial security, and fulfilling future life goals. Saving 20% of your monthly income will help you buy a car in two years, have children in five years, or even pay off your awful student loans in a record-time of 10 years. While 20% of your income may seem very little, if untouched, your savings will increase in no time. All good comes to those who wait… so please, be patient!
Amelia places 20% of her net income into her savings account. That’s $750 dollars worth of savings. If Amelia sticks to the 50/30/20 rule, she’ll have saved $9000 in one year. In just five years, Amelia will find herself with an impressive $45,000 in her savings account just from putting a little aside every month. Plus, there might be a little extra left over from the “fun money” every month (in the example above, Amelia had an extra $125 from her 30%, so her monthly savings got a little extra bump).