The 50-30-20 Rule. Can It Help You Manage Your Money?

What Is The 50-30-20 Rule?

If you’ve researched ways to manage your finances better, you may have heard mention of the 50-30-20 rule. Great… another rule to follow that will make you rich, you may be thinking. Well, this one is pretty simple and makes a fair bit of sense.

So what actually is it, how do you implement it and can it work for you?

Let’s investigate

This rule could be described as a ‘rule of thumb’ (which just means that it’s an approximate method) and is designed to help you allocate your income to three categories: needs, wants, and savings.

The 50-30-20 rule is a guideline for budgeting that suggests dividing your after-tax income into three categories:

Category 1:

50% for your needs: This includes your essential expenses, such as rent or mortgage payments, utilities, groceries, transportation, and insurance.

Note: It’s also a good rule to keep rent or mortgage payments below 30%.

Category 2:

30% for your wants: This is the discretionary spending that you use for non-essential items, such as dining out, entertainment, and vacations.

Category 3:

20% for your savings: This is the portion of your income that you set aside for future expenses, such as retirement or emergencies.

Note: In effect, this is the amount that probably should be invested. I would recommend that the first priority should be to set up an emergency fund separate from this 20%. Then when a decent-sized emergency fund is set up, the entire 20% can be invested.

The 50-30-20 rule is flexible and can be adjusted based on your individual circumstances.

For example, if your rent or mortgage payment is more than 30% of your income, you may need to adjust your percentages to ensure you have enough money for your other expenses.

So what are the pros and cons?

Pros of the 50-30-20 rule:

First pro:

One of the main benefits of the 50-30-20 rule is that it is simple and easy to understand. It provides a clear framework for managing your money and ensures that you are prioritizing your expenses in a way that makes sense.

Second pro:

Another advantage of the 50-30-20 rule is that it encourages saving. By allocating 20% of your income to savings, you are building a solid financial foundation for the future. This can help you achieve long-term financial goals, such as buying a house, starting a business, or retiring comfortably.

Third pro:

Additionally, the 50-30-20 rule provides a sense of balance between your needs and wants. By limiting your discretionary spending to 30% of your income, you are still able to enjoy the things you love while also ensuring that you are not overspending.

Cons of the 50-30-20 rule:

While the 50-30-20 rule is a good starting point for managing your finances, it does have some limitations.

First con:

It assumes that everyone has the same financial priorities and circumstances. However, this is not always the case.

Second con:

For some people, their essential expenses may be more than 50% of their income, leaving little room for discretionary spending or savings. In this case, the 50-30-20 rule may not be practical.

Note: If this is the case then I would suggest that it’s the ‘essential’ expenses that should be adjusted rather than the rule itself.

Third con:

The 50-30-20 rule does not account for debt repayment. If you have high levels of debt, such as student loans or credit card debt, you may need to allocate a larger percentage of your income to debt repayment rather than savings or discretionary spending.

Note: The advice here should be to work hard at reducing debt first and then implement a savings plan.

And a fourth con:

Finally, the 50-30-20 rule does not take into account the fluctuation of income or unexpected expenses. If your income fluctuates from month to month, or you experience an unexpected expense, such as a medical bill or car repair, you may need to adjust your percentages to accommodate the changes.

Note: An emergency fund would address this problem.

My thoughts on the rule

In my opinion, the rule definitely has some value, especially as a starting point for getting your finances organised and starting on a more responsible approach towards managing your money.

Though I listed one more con than pro, I feel that the pros are much stronger. Any system that encourages saving a set percentage each month is a step in the right direction. Exactly what that percentage should be could be debated forever.

But of course, a rule is only as good as the discipline applied to sticking with it. It’s great to have a plan. Any plan is generally better than none at all. The 50-30-20 rule forces people to analyse where their money is going and to live life around a structure that places at least some emphasis on saving.

What if essential expenses are greater than 50% of your income?

In this case, I think you are likely living a little beyond your means.

This could be that your rent is greater than 30% of your income or there could be additional expenses that are really getting in the way of fast-tracking your savings and investment plans. This is often in the form of car loan repayments.

The obvious solution is to either cut back on these expenses or find a way to increase your income without increasing expenses.

This is the great benefit of the rule. It encourages an analysis of spending and allows you to make decisions to improve your financial situation.

My suggestion is firstly to save an emergency fund of 3-6 months of expenses. Hopefully, this is never ever needed. But if it is, then your savings will not be affected when emergencies occur and your plan can remain on track.

Secondly, lower essential expenses below the 50% threshold. This may be the hardest part and the part that meets the most resistance.

Thirdly do some research into where exactly to save/invest that vital 20%. This is a whole separate blog/discussion.

Conclusion

There are many ways to organise our lives, rules that we could follow and steps to take in our journey to financial freedom. Our circumstances and goals vary greatly. But any structure that helps us and any habit that we can stick to is bound to be a step in the right direction. Give the 50-30-20 rule a try.

Let me know what you think.