Monday, May 27, 2024

What Is The 50/30/20 Budget Rule? Explanation & Examples

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If you’re not into traditional budgeting, where you place all of your spending into rigid categories, then the 50/30/20 budget rule might be for you.

This financial management budgeting method is broken into three main categories: 50% needs, 30% wants, and 20% savings and investing. It’s designed to take a full picture of one’s monthly living expenses in the simplest way possible and remove the nitty gritty details that can bog someone’s bank account down with complications.

So, in theory, if your after-tax income is $5,000 a month, $2,500 should go to your needs, $1,500 to your wants, and $1,000 to your savings and investing goals. Let’s talk more about how this all works.

50%: Needs

The first section of the budget is devoted to your needs. Needs represent the essential items that allow you to survive, such as:

  • Mortgage payments
  • Groceries
  • Health insurance
  • Utilities
  • Transportation
  • Debt payments

While it seems like a simple solution, designating what is genuinely an essential need or not is more complicated than it looks. To set this budgeting system up correctly, you must hone in on your spending habits and financial goals. An excellent way to frame necessary expenditure within the 50/30/20 rule is to phrase it as the following question: If you lost your job or source of income today, what spending would you still need to survive?

Even if you’re financially secure, these questions are critical to ask, as they bring us back to the basics of what is important or not. Stopping each morning for Starbucks might feel nice, but you can easily rack up more than $100 monthly on coffee alone. In reality, you don’t need to drink Starbucks coffee. You could save hundreds, if not thousands, of dollars annually by brewing your coffee at home.

If your needs take up more than 50% of your budget, then it’s time to consider cutting costs or finding ways to increase your monthly income.

Generally speaking, housing and transportation are your largest monthly expenses. For those working as a 1099 contractor, add healthcare to that list. Finding ways to decrease significant living expenses will help you come within budget. For example, if your car payments swallow $600 of your monthly spending budget and you’ve recognized it as a painful expense, refinancing, depending on if you have a high-interest rate or selling it for a cheaper vehicle, could free up a lot of extra cash per month. Cash that can be put elsewhere, such as investments, savings, or debt repayments.

Redirect funds you save towards savings or investments like real estate or stocks. Stocks are relatively inexpensive and easy to get into compared to real estate. Still, as we’ve said at BiggerPockets a billion times, it’s always the right time to start your real estate investment journey!

30%: Wants

The following 30% of your budget should be your wants. Wants are things that you don’t necessarily need to survive.

Some wants are:

  • Shopping
  • Dining out
  • Entertainment
  • Nightlife
  • Travel

This is the more controversial part of the budget. Critics suggest you should not dedicate 30% of your budget to wants. Instead, they say 30%-40% should go towards investments and savings; as your money scales, the wants budget naturally increases. 

Say you do use 30% of your budget towards wants. Your goal should be to limit the amount you’re spending. 

An easy place to start is to look at your subscription services. Disney+, Hulu, Netflix, and Paramount+ are all excellent streaming services, but do you need to subscribe and spend money on every one of them?

You can also look at how much you spend on take-out and restaurants. For example, cooking four or five meals weekly can save you a few hundred dollars at the end of the month.

Of course, just like the needs, if you can’t cut down on costs, you’ll need to increase your net income to balance the budget. Going over 30% on wants is an easy way to recognize that you’re spending too much money.

Short-term savings

You should include short-term savings in the wants category as well. Saving for a vacation, a new car, or a fancy computer are short-term savings goals that fall into the wants category. 

Whatever you’re saving for, you don’t want your long-term savings delayed because of short-term wants. Distinguish between what is more important and keep a future-oriented attitude towards savings.

20%: Saving and Investing 

The last section of the 50/30/20 rule is to dedicate 20% of your monthly after-tax income to your savings account or investments. We’ll always emphasize that it’s vital that you look out for your future self. 

While 20% might not seem like a lot, and in reality, it isn’t, any savings you account for will put you in a better financial situation.

What type of savings or investments make sense, then? Let’s go over the five major categories to focus on.

Saving #1: Emergency fund

If you haven’t started one, you must build an emergency fund. This is an important goal for everyone. 

Aim for a starting emergency fund of $2,000. After that, you can scale it to what you feel would protect you most.

Emergency funds are crucial buffers between you and the world for unexpected expenses. If you lose your job, your car breaks down, or your dog needs surgery, you’ll be liquid enough to pay your way out of trouble. 

Saving #2: Retirement account 

Retirement accounts are also critical. According to a SimplyWise survey, 40% of Americans are worried that they cannot retire, and the vast majority only have $65,000 in retirement savings. That’s certainly not enough to live off. Try saving at least 15% of your gross income for retirement.

Building up your retirement contributions early protects your future self. You might already have a 401(k) through your employer, but other options like a Roth IRA exist. Be sure to do your research on what works best for you.

Related: 401(k) vs. Roth IRA: Which is best for you?

Saving #3: High-interest debt

Some people also use this 20% to get a head start on paying off high-interest debt. While this is not ideal, it’s not a bad option if you’re overwhelmed with debt on something like credit cards. Sure, making the minimum payments on credit card debt is fine, but an extra $50 each month can shave years off your overall debt payments, depending on how much you owe.

Those are three major categories of savings to look at. As for investments, these are the ones you’ll want to consider.

Investment #1: Real estate

Real estate is one of the best investments to make. It has a long history of stable, consistent appreciation, with few hiccups in between (i.e., 2008). Second, real estate is constant; the home you buy will usually remain in place unless a natural disaster or something else occurs that damages or destroys the home. 

Finally, real estate is leverageable. While yes, you can trade stocks on margin, it’s risky. On the other hand, you can acquire real estate with a 20% down payment. Depending on your financing terms, even less. There are also plenty of ways you can execute creative financing strategies.

Investment #2: Stocks

Another popular investment to make is in stocks. Compared to real estate, getting involved in stock investing is much easier. All you have to do is create a brokerage account, verify your identity, and get started.

Whether you plan on being an active or passive investor, note that long-term investments save money in taxes. While stocks are volatile compared to real estate, 30-year outlooks of stock indices show that stocks tend to appreciate over time.

Example of the 50/30/20 Budget Rule

Let’s say that after taxes, you make $5,000 a month. The 50/30/20 budget rule applies to the $5,000 as follows:

  • 50% = $2,500 towards your needs
  • 30% = $1,500 towards your wants
  • 20% = $1,000 towards savings and investments

Benefits of the 50/30/20 Rule

The 50/30/20 rule benefits individuals in many ways. From reaping the benefits of debt repayment to creating financial security, here are just a few reasons why you should consider following this method:

Simplify budgeting

The 50/30/20 rule is straightforward. Divide your net income into different budgeting sections. 

Pick and choose worthy expenses

With the 50/30/20 rule, you must choose what’s worth your dollar without going over budget or creating an uproar of debt.

Promote savings growth

Set money aside and forget about it. A good rule of thumb is to allocate a healthy 20% of your take-home pay to savings, and you can build up an emergency fund for unforeseen circumstances or future goals.

Create financial security

You’re making yourself a priority by following the 50/30/20 rule. This ultimate lifetime money plan helps you balance your take-home pay to help meet short and long-term financial goals and provides a sense of security.

Is The 50/30/20 Budget Rule Right For You?

The simplicity behind the 50/30/20 rule makes it easy to build a budget that fits your lifestyle. As we’ve discussed, one of the most common changes is switching out the 20% and 30% parts of the budget so that you’re emphasizing savings over wants. If you’re working on building your investment portfolio, it would be more beneficial to set aside 30% of your monthly income for those projects, then spend 20% of your take-home pay on wants. 

The purpose is to create a balanced monthly budget of 100%. If you can lock in these numbers consistently, you should see real changes in your financial journey.

The Bottom Line

The 50/30/20 rule is excellent if you want to try something other than traditional budgeting. It gives you ballpark numbers to spend on each category while still setting aside what you need to live life as you see fit.

While it might not make sense for an investor to apply the 50/30/20 rule as is, the concept behind percentage buckets might be something worth considering depending on personal circumstances. Perhaps you can try a 50/40/10 combination, favoring 40% in savings accounts and investments. Or a 40/40/20 variety.

If it can help you achieve your financial goals, then it’s worth considering.

Ready to succeed in real estate investing? Create a free BiggerPockets account to learn about investment strategies; ask questions and get answers from our community of +2 million members; connect with investor-friendly agents; and so much more.

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.

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