To better understand how to apply the rule, we’ll look at its background, how it works, and its limitations, and we’ll 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.
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 not very easily. They include things like:
RentGroceriesUtilities, such as electricity, water, and sewer service
30% to Wants
Wants are what you desire but don’t actually need in order to survive. They might include:
HobbiesVacationsDining outDigital 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 Senator 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:
An Example of the 50/30/20 Rule of Thumb
Here’s an example using the steps above: 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.
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 flip side, if you have big goals, like retiring early or buying a house in a high-income area, 20% might not be enough. For example, the average home price of a house in San Francisco was more than $1.6 million in June 2022. You would need to save, on average, $320,000 to afford a 20% down payment there.
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 whether you’re actually hitting them.
The 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:
The 80/20 Rule: With this method, you immediately set aside 20% of your income for savings. The other 80% is yours to spend on whatever you want, with no tracking involved. The 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.
