The 50-30-20 Rule: Your Path to Financial Freedom
Have you ever heard of the 50-30-20 “rule” for personal finances? Are you wondering what it's all about and how your finances compare? Well, you’re in the right place my friend!
In this post, I will explain what this so-called rule is (and it's not really a “rule” - I’ll get into that too), explain the different elements of the rule, and talk about some important exceptions to the rule. I will also introduce the Financial Fit Check - it's a tool that you can use to see how your spending and saving compares to the 50-30-20 rule.
Understanding the 50-30-20 Rule
First things, first: the 50-30-20 rule isn’t really a rule, it's more of a “rule of thumb”! There is nobody that is going to come and judge you or get you in trouble if you are not following it. What it is though, is a guideline to follow so that you can be sure that you are living within your means, you aren’t stretched too thin, and you are setting aside money for your financial goals. It’s that simple!
The 50-30-20 rule simply means that a maximum of 50% of your income should go to your “needs”, a maximum of 30% of your income should go to your “wants”, and at least 20% of your income should go to your extra debt payments, savings, and investments combined. It applies best for people who are in their working years.
Because it is based on percentages, the “rule” can be applied to any income level. And if your income changes, the rule can help you avoid lifestyle creep (when your spending on “wants” increases too much relative to your income). It’s also a really helpful guideline for times when your spending on a “need” increases (hello to everyone’s grocery bill). The 50-30-20 rule will guide you to look at your overall percentages and find areas that you can adjust to bring you back to closer to the ideal percentages.
Finally, if you haven’t really been paying attention to your finances lately (are you doing the ostrich head in the sand maneuver?) and things are feeling very stressful at the moment, the 50-30-20 rule is a really good place to start on your journey towards getting back on track and re-gaining control of your finances. It’s never too late!
Your Needs (50% or less)
The 50-30-20 rule starts with your “needs” at 50%. This portion of your income, ideally 50% or less, is dedicated to covering your essential needs. These are the expenses that are necessary for your basic well-being and the “must pays”. This category includes things like:
Rent or mortgage payments
Utilities (electricity, water, gas)
Groceries
Car payments
Gas
Health insurance
Phone bills
Minimum debt payments (credit cards, student loans, mortgage etc..)
Keeping these expenses at 50% or less of your average monthly income gives you the space to put more of your money towards wants, savings, repaying debt, and investing. When your needs creep up higher than 50%, things will feel tight. You may even find yourself on the paycheck-to-paycheck cycle. The idea is to keep this number down and put your money to work on enjoying life and reaching your longer-term financial goals.
If you find that your needs are higher than 50% of your average monthly income, it may be time to make some adjustments and give your budget some breathing room. This is the hard part. Is your rent too high relative to your income? Do you really need to have two financed vehicles? Can you make some adjustments to your grocery budget? Or, can you increase your income so that this percentage comes down a bit?
Your Wants (30% or less)
“Wants” make life enjoyable and aren’t strictly necessary for survival. These are expenses like:
Dining out
Take out and food delivery
Entertainment (movies, concerts, hobbies)
Gifts
Non-essential subscriptions
Some financial gurus out there believe that if you have debt you shouldn’t be spending on your wants.
If you are in debt the only reason you should step foot into a restaurant is because you work there! - David Ramsey
I disagree. I believe that it is more realistic for you to continue to enjoy life, within your means, while you work towards reaching your financial goals. 30% or less on your wants is a good guideline.
Spending more than 30% on your wants? It may be time to look at ways to cut back, so that more of your money can go towards your longer-term financial goals.
As a money coach, I have worked with clients on finding and canceling unneeded subscriptions, looking at spending habits and patterns, and really dialing in their financial goals and values.
Sometimes what’s needed to really make a change to your spending is clarity. For example, when you are clear that you want to save for an emergency fund and you know your goal and timeline, it is easier to focus on other areas of your budget.
Saving, Investing, and Extra Debt Repayments (20% or more)
The last, and arguably the most important, part of the 50-30-20 rule is that 20% or more of your average monthly income should go towards saving, investing, and extra debt repayments.
Saving up for an emergency fund, a trip, a down payment, or a big purchase? The amount you are putting towards these goals each month would count as savings.
Investments include your regular post-tax contributions to your investment accounts. In the United States, this would include contributions towards your IRA, Roth IRA, 529 Savings Plan, and HSA. In Canada, this would include contributions to your RRSP, TFSA, and RESP.
And finally, extra debt repayments include payments you are making towards your debt above the minimum monthly payment. For example, if a credit card you are trying to pay off has a minimum monthly payment of $80 and you are putting $100 towards it each month, $80 would be a “need” (since you have to pay this) and $20 would be an extra debt payment.
Some Important Exceptions to the 50-30-20 Rule
As I mentioned above, the 50-30-20 rule is not really a “rule” and more of a guideline or rule of thumb. And there are many situations where the “rule” doesn’t really make sense.
There are some seasons of life or situations where you may have to put more than 50% of your income towards your needs. Parents with young children in daycare come to mind. Those high daycare costs are temporary so perhaps you can deal with a higher percentage of your income going towards your “needs” for these years, knowing that when the kids start school you can contribute more of your income towards savings, retirement, or extra debt payments.
Another common situation where you may have to spend more on needs, is if you are going through a major life transition such as a divorce. It may be that your spending on needs will be very high for a period of time. Ideally, over time your percentages will re-align.
For the lucky folks who have a pension or are part of an employer-sponsored retirement plan, you may not have to put as much of your post-tax income towards saving for retirement. I would recommend using some of the tools available online to make sure that you are on the right track. For Canadians, the Government of Canada has a helpful tool here.
Another reason you may not have to contribute as much towards the last category (retirement, savings, extra debt repayments) is if you already have enough saved to meet your goals and have no debts. Maybe you’ve consciously decided that you don’t have as many longer term savings goals right now and that you want to spend more on your wants. It's time to live it up (within your means of course)!
The Financial Fit Check
Want to know how your finances stack up against the 50-30-20 rule? I’ve created an easy-to-use Excel Spreadsheet that you can use to see how your spending and saving compares to the ideal percentages. You simply plug in your numbers and then check the “Your Results” tab to see the result. There is absolutely no math or formulas to use! You can even put in weekly, bi-weekly, or yearly amounts and the tool will automatically calculate the monthly amount. I'd love for you to try it out. Here’s the link.
Conclusion
In this post, I’ve explained what the 50-30-20 "rule" is, explored the three categories, and explained some important exceptions to the “rule”.
Let's review the key takeaways: Your "needs" should ideally eat up 50% or less of your income, covering must-haves like housing, utilities, groceries, and minimum debt payments. By keeping this category in check, you free up room for your "wants," ensuring that life remains enjoyable as work towards meeting your financial goals. That 30% earmarked for your “wants” strikes the right balance.
Now, the real heart of the matter lies in the 20% or more that's dedicated to saving, investing, and extra debt payments. This 20% guideline ensures you're constructing a financial safety net, growing your wealth through investments, and chiseling away at your debts.
Life, as we all know, isn't a simple, one-size-fits-all journey. Various scenarios, like raising children or navigating life transitions such as divorce, may call for temporary tweaks to these percentages. Or, you might be fortunate to have employer-sponsored retirement plans or have already reached your financial milestones, which allows for more flexibility in your spending.
If you are eager to test the waters and see how your spending and saving stacks up to the 50-30-20 rule, please check out the Financial Fit Check, a user-friendly Excel Spreadsheet that I created.
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