Understand the 50/30/20 rule and succeed in its application
July 27, 2022
50/30/20 rule is a method to manage your money. It consists of easy and effective budgeting, in which you divide your monthly income after taxes into three parts: 50% for needs, 30% for wants, and 20% for savings or paying debts.
With this simple and sustainable method, you can have a more balanced financial life. Plus, you save the stress and the time you use analyzing your spending every time you over-consume. By structuring your spending habits this way, you're making it easier for you to reach your financial goals.
The 50/30/20 rule comes from the book, All Your Worth: The Ultimate Lifetime Money Plan, written by Elizabeth Warren and Amelia Warren Tyagi in 2005. They proposed how to control your finances and balance your money without the need for complex budgets.
With the 50-30-20 rule, we divide our after-tax income into three categories mentioned below:
50% for needs
It refers to essential expenses, without which it would be difficult to live. This includes things such as monthly rent, electricity, gas bills, public transportation or gasoline, health and of course basic groceries.
If we assume that your income after taxes is $2,000, that means that $1,000 should cover the basic needs that we just mentioned.
In the event that you find that your needs cover more than 50% of your income, you may want to consider making changes in your life to lower those expenses. You may need to look for cheaper rent or less expensive food products than the ones you usually buy.
30% for wants
This percentage can be used to fulfill your wishes. These are characterized as "non-essential expenses," meaning things you want to spend your money on but aren't necessary for living. For example, dining out, gym membership, clothing, entertainment subscriptions (Netflix, Disney Plus, Amazon Prime) or groceries (other than the essentials).
If we continue assuming that your income is $2000, it means that for this 30% you have $600 for your wants. Try not to exceed this amount, but if you do, consider which of these expenses you can reduce.
20% for savings
At this point, we only have 20% of your income left, either to save or to pay off debt. While you may think that debt is part of needs (50%), Warren and Tyagi say that any reduction in debt qualifies as saving, since it reduces future interest.
If we continue to assume that your income is $2000, for this 20% you have $400, which you could put towards a fixed goal such as an emergency fund, a down payment on a house or any other personal financial plan. Think about how much you could save in just one year with this rule, and dream big.
Don't think that following the 50/30/20 rule means you can't enjoy life. On the contrary, it allows you to be more aware of your money.
Aspects to consider to achieve 50/30/20 rule:
The first step is to calculate your income after taxes. If you are an employee with a fixed salary, it is very easy. You can check last month's check to be sure of the exact figure. On the other hand, if you are self-employed, what you earn monthly is subtracted from the expenses that your business has and that would be the value of your income after taxes.
You can start with a list divided into three categories: needs, wants, and savings.
Analyze what they are and how much you spend on each of them. If necessary, reduce some or eliminate them from the list.
Once you have the exact figure for each category, ask yourself if it corresponds to the 50/30/20 rule, your income and your goals. Remember that wants are small —basic things that allow us to enjoy life— but keep in mind that the more you reduce those wants, the more likely you are to reach your 20% savings.
Small businesses are at the heart of everything we do at Tru Capital, that is why more than a financing partner, we want to be an educational tool for building healthy finances for your business. We want to provide you with the information and guidance you need to create great businesses. If you have any questions or would like more information, please call or text us to this number: 917-243-3113.