The 50/30/20 rule of thumb is a way to allocate your budget according to three categories: needs, wants, and financial goals. It’s not a hard-and-fast rule but rather a rough guideline to help you build a financially sound budget.
To better understand how to apply the rule, we’ll look at its background, how it works, and its limitations, plus go through an example. In other words, we’ll show you how and why to set up a budget using the 50/30/20 rule of thumb yourself.
- The 50/30/20 rule of thumb is a guideline for allocating your budget accordingly: 50% to “needs,” 30% to “wants,” and 20% to your financial goals.
- It was popularized by Elizabeth Warren and her daughter, Amelia Warren Tyagi.
- Your percentages may need to be adjusted based on your personal circumstances.
- It’s only a rule for how to plan your budget; it doesn’t actually track your budget for you.
What Is the 50/30/20 Rule of Thumb?
The 50/30/20 rule of thumb is a set of easy guidelines for how to plan your budget. Using them, you allocate your after-tax income to the following categories.
50% to Needs
Needs are what you can’t live without, or at least very easily. They include things like:
- Utilities, such as electricity, water, and sewer
30% to Wants
Wants are what you desire but don’t actually need to survive. They might include:
- Dining out
- Digital and streaming services like Netflix and Hulu
20% to Financial Goals
This category covers two main areas:
- All savings, such as retirement contributions, saving for a house, and setting money aside in a 529 college savings plan (note that contributions to a 401(k) come from your pre-tax income)
- Debt payments
Because this is just a guideline for planning your budget, you’ll need to supplement it with something to monitor spending, such as a budget tracker like YNAB (You Need a Budget), Mint, or Quicken. You can then set the 50/30/20 percentages as targets within whichever budget tracker you prefer.
Where Does the 50/30/20 Rule of Thumb Come From?
The 50/30/20 rule was popularized by Sen. Elizabeth Warren (a Harvard law professor when she coined the term) and her daughter, Amelia Warren Tyagi, in the book All Your Worth: The Ultimate Lifetime Money Plan. It was designed as a rough rule of thumb for working-class families to plan their spending in order to prepare for the future and unforeseen circumstances.
How to Use the 50/30/20 Rule of Thumb for Budgeting
Most people save too little, and unknowingly spend too much. The 50/30/20 rule of thumb is a way to become aware of your financial habits and limit overspending and under-saving. By spending less on the things that don’t matter that much to you, you can save more for the things that do.
Here’s how it works:
- Calculate your monthly income: Add up how much you receive in your bank account each month. If you have a workplace retirement plan, find out how much is withheld and add that amount back in with your take-home pay. If you pay estimated taxes, reduce your monthly income amount accordingly.
- Calculate a spending threshold for each category: Multiply your take-home pay by 0.50 (for needs), 0.30 (for wants), and 0.20 (for financial goals) to see how much you should ideally spend in each category.
- Plan your budget around these numbers: Think of these three categories as “buckets” that you can fill with monthly expenses. List and tally your monthly expenses under the category each falls into and see if you’re spending less than the monthly targets you established in the prior step.
- Follow your budget: Track your expenses each month, and make changes where needed, in order to stick to your spending thresholds going forward.
An Example of the 50/30/20 Rule of Thumb
Here’s an example using the steps above:
- Calculate your monthly income: Let’s say you and your spouse have a total of $4,787 deposited into your bank account each month from your jobs. You both check your pay stubs and see that a total of $532 was taken out for 401(k) contributions. This means that together, your monthly income is $5,319 ($4,787 + $532).
- Calculate a spending threshold for each category: Based on the 50/30/20 rule, the amount you should allocate to “needs” is $2,659 ($5,319 x 0.50). The amount you should allocate to “wants” is $1,596 ($5,319 x 0.30). The amount you should allocate to financial goals is $1,064 ($5,319 x 0.20). Since you’ve already contributed $532 to your 401(k)s, use the remaining $532 to pay down debt or save for other financial goals.
- Plan your budget around these numbers: Go through your budget to either plan out your spending, or see how well your spending is already aligned within these targets.
|Total Monthly Income||$5,319|
|Needs: $5,319 x 0.50||$2,659|
|Wants: $5,319 x 0.30||$1,596|
|Goals: $5,319 x 0.20||$1,064|
Why the 50/30/20 Rule of Thumb Generally Works
Figuring out your finances is confusing and it’s often hard to know where to start. That’s one reason the 50/30/20 rule of thumb works so well: It’s an easy way to get a handle on something that can otherwise be intimidating.
Even if you don’t take it any further by tracking how well you stick to these targets, it’s still a good way to take your financial pulse.
Grain of Salt
Like any rule of thumb, it’s a good idea to take the 50/30/20 rule of thumb with a grain of salt. Here’s why:
Potential for Gray Areas
It’s sometimes hard to sort out your spending according to three categories. Everyone needs to eat, for example, but some groceries fall into the wants category (like sugary sodas and unhealthy snacks).
Can Be Difficult for Low-Income People
If you’re earning just enough to make ends meet, you may struggle to save 20% of your income regardless of how you live, especially if you’re supporting a family.
Savings Might Not Be Enough
On the flipside, if you have big goals like retiring early or buying a house in a high-income area, 20% might not be enough.
For example, you’d need $330,000 to afford a 20% down payment on a median-priced home in San Francisco—almost exactly the entire cost of an average-priced home nationwide.
You Still Need to Track Your Budget
The 50/30/20 budget rule is only one piece of the budgeting puzzle. It’s good to shoot for these percentages, but unless you track your spending, you’ll never know if you’re actually hitting them.
50/30/20 Rule of Thumb vs. Other Budgeting Methods
The 50/30/20 rule of thumb isn’t the only game in town. Here are a few other budgeting techniques that might work better for you:
- 80/20 Rule: With this method, you immediately set aside 20% of your income into savings. The other 80% is yours to spend on whatever you want, no tracking involved.
- 70/20/10 Rule: This rule is similar to the 50/30/20 rule of thumb, but you instead parse out your budget as follows: 70% to living expenses, 20% to debt payments, and 10% to savings.