Only 28% of Americans are considered financially healthy, according to a study by the Financial Health Network.
The situation should alarm you. It should also motivate you to take control of your finances. The truth is that you can obtain financial security even if you don’t make the big bucks.
What you do need is good budgeting. Most financial experts agree that you can live within your means without feeling deprived. You just need to spend less than you make.
Enter the 50/30/20 strategy. Here’s how this budgeting method can allow you to live well, accumulate savings, build an emergency fund, and improve your financial well-being.
What exactly is the 50/30/20 budgeting method?
While 67% of Americans make budgets, high household debt details that they could do a better job. The complex nature of tracking income, bills, and everyday expenses makes it tough to stay in control.
The 50/30/20 budgeting method simplifies the complex task of managing finances. It takes your expenses and separates them into three categories:
- Needs: 50% of your after-tax income
- Wants: 30% of your after-tax income
- Savings: 20% of your after-tax income
The 50/30/20 budgeting method works for many people because it streamlines how you manage your take-home pay. Every expense falls into one of those larger categories.
When making your 50/30/20 budget, first calculate your after-tax income (don’t use pre-tax income). Your after-tax income is what you have left after paying federal, state, and local income taxes, as well as Medicare and Social Security. Don’t include money you put aside for retirement contributions or health savings accounts (these expenses fall into the savings category!).
Next, place your expenses into one of these three categories. Add up the monthly totals for each one, ensuring you don’t exceed the limit for any category. If you'd like to get more detailed on planning your individual expenses, check out our article on the zero sum budgeting strategy!
Sounds simple, right? It is!
But success with this budgeting method requires discipline. You must take a careful inventory of all your expenses and stick to the plan.
Necessities: 50% of your after-tax income
To use the 50/30/20 budgeting method effectively, you must categorize your expenses correctly. 50% of your expenses are for necessities—those expenses that you can’t avoid.
Your needs probably include expenses like:
- Childcare or children’s education
- Minimum loan payments (student loans, credit card debt, auto loans, etc.)
You can’t really ignore these expenses. But they shouldn’t equal more than 50% of your take-home pay. If they do, you’re probably living a lifestyle above your means.
If you find that you spend too much on necessities, take steps to cut down where you can on these expenses. You’ll find that you have more options than you may think.
For instance, if your household spends $450 per month on food, you could employ cost-saving strategies to reduce your expenses by $50–$100/mo. As grocery shopping experts advise, you can save hundreds per year by comparing per unit or ounce prices, going generic, and buying essential food in bulk when it’s on sale (e.g., rice, pasta, meat, etc).
Wants: 30% of your after-tax income
Distinguishing between wants and needs can get difficult. Ask yourself: Do I need this for my job or daily life? If you don’t, it’s a want—not a need.
For instance, a monthly internet bill may be a convenience for those who don’t do any work from home. However, if you work from home or need WiFi access to work, it’s a necessary expense (and therefore should fall under the necessities category).
In short, your wants should consist of whatever conveniences make your daily life more enjoyable. This could include:
- Entertainment, like going to a concert or ball game
- A monthly cable or Netflix subscription
- That nice bottle of whiskey every once in a while
- Occasional travel (e.g., 10 days vacation time per year)
- Dining out once a week
Be careful: Your wants shouldn’t include extravagant monthly trips to Las Vegas. If you want to get on the right financial track, curtail any lavish spending for now. Spending on your wants shouldn’t exceed 20% of your take-home pay.
If you find that you spend too much, you have lots of ways to reduce those expenses. One way to quickly reduce your spending on wants is to stop dining out. If you spend $20 two times per week eating out, you could save $160 per month by not going out to eat.
Savings/Debt: 20% of your after-tax income
You should allocate the final 20% of your take-home pay for savings and debt. Your savings contributions could include the following:
- Emergency fund contributions
- Insurance contributions
- Retirement contributions, like a 401(k)
- Health savings account contributions
- Money for your child’s college education
- Investments in stocks, real estate, and other assets
Building your emergency fund is key to maintaining financial security. Because when the unexpected happens, you need to be prepared. The general rule is to save 3–6 months of living expenses in your emergency fund.
Paying off debt (anything beyond minimum payments) also belongs in the 20% category. That could include extra payments on the following:
- Credit cards
- Student loans
- Auto loans
- Your mortgage
An example of the 50/30/20 budgeting method
Let’s say your take-home pay is $5,000 per month. Using the 50/30/20 strategy, you spend the following:
- No more than $2,500 on your rent, utilities, transportation, and minimum debt repayments.
- No more than $1,500 on travel, dining, entertainment, and random fun (like that spur-of-the-moment helicopter ride)
- No more than $1,000 on savings and debt, such as retirement contributions and extra payments on your student loan
Stick to this strategy, and your financial standing will improve over time. When it comes to your quality of life, you won’t feel deprived, especially once you get used to the 50/30/20 budget lifestyle.
Finally, if it helps with creating your budget, use a spreadsheet or calculator. Keep track of what you actually spend on a day-to-day basis. There are budget trackers out there that can automate the process and make it seamless.
Why the 50/30/20 plan works
As Harvard Business research shows, most of the time, the simplest solutions are the best ones. The same holds true when it comes to personal budgeting.
The 50/30/20 budgeting method offers a simple, intuitive plan for people to reach their financial goals. With just three categories to manage, people have a better idea of how to spend less and save more—without sacrificing their lifestyle.
Remember: At the end of the day, discipline is the key tool people need in order to take control of their finances.
So if you’re looking to improve your finances, give the 50/30/20 budget a try. Who knows? You may just end up surprising yourself.