What is the 50/30/20 budgeting rule?

US Senator Elizabeth Warren created the 50/30/20 budgeting rule in her book, All Your Worth: The Ultimate Lifetime Money Plan. The general idea was to divide up your after-tax income and allocate it to three categories:

• 50% for needs
• 30% for wants
• 20% for savings

Please remember that these percentages are just a guideline, and you should make adjustments based on your financial goals. The key takeaway was to understand better where your money should be going versus where it’s actually going. 

Budget 50% for needs

This is by far the largest category. Ideally, half of your after-tax income should go towards expenses to cover your necessities. This could include rent or mortgage payments, car payments, credit card bills, insurance(s), and other debt payments. Variable expenses can consist of utility bills and groceries, which can be hard to control. It is important to note that every person is different, so there may be an expense that is an essential monthly expense which isn’t mentioned above. 

If your expenses are larger than your income, you may want to either cut down on “wants”, downsize your lifestyle, or increase your income. Here are some ideas on what you can try to help reduce your expenses or boost your income:

• Use public transportation or carpooling  instead of Uber, taxi, or driving your own car
• Downgrade your phone or cable plans if possible based on what you actually need
• Learn how to cook new recipes versus eating out 
• Do some side hustles like food delivery, online tutoring, virtual assistance, business consultant, etc.
• Consider getting a second part-time job on the side  

Budget 30% for wants

Life is too short to just work and not enjoy your life for a bit. That being said, your “wants” doesn’t need to be as extravagant like getting the latest iPhone or designer goods. It can be the simple pleasure life has to offer like going out with friends or family or trying out a new recipe or cuisine.

It’s not recommended that you fully spend 30% of your after-tax income every pay cheque on your wants, but rather, it’s the maximum amount you can budget for it. The purpose of creating and following a budget is to still come under the amounts set for each category. 

For example, if you are a tech enthusiast and you have a bit of wiggle room in your budget for your “wants” category, that doesn’t mean you should go out and spend it on the latest gadget. Instead, try to delay your purchase and pick it up at a discounted price later on. That way, you can put the extra savings towards bigger purchases like buying a home or long-term goals like saving up for retirement. 

Budget 20% for savings 

The first thing you should do with this 20% of your after-tax income is to pay down any high-interest debt (credit card debt, payday loans, car loans, student loans, etc.) If you don’t have any debt, or you’ve successfully paid it off, then put this money towards setting up an emergency fund. 

Life can have unexpected events that happen like car repairs, vet bills, medical bills, and getting laid off that can mess up your budget. Building a nest egg is one way to protect yourself from such scenarios. If you have a stable job, you should aim to build 3-6 month worth of expenses. If you’re self-employed, you have to stash away more cash than someone who has a stable job in case you have slow months during the year. Your aim should be to build 6-9 months worth of expenses for an emergency fund. 

Once you’ve built up your emergency fund, you can start putting some money away towards your next long-term goal such as saving up for a down payment for your first home. 

Under the Home Buyers’ Plan (HBP), you can borrow up to $35,000 of your own funds in your RRSP as a source of down payment and pay it off within 15 years. If you are purchasing a home with your spouse or common-law partner, that’s $70,000 that you can borrow! 

So where do you start?

To begin with the 50/30/20 budget, calculate your monthly after-tax income on average. You can do exact amounts or round down to the nearest dollar. Once you have that number, split it into the allotted percentages to get each category’s maximum budget.

Then take a look at your spending habits over the past couple of months and start identifying which category those particular expenses fit into. Please be mindful that this is a guideline and not an absolute. For each expense, ask yourself, “Was it a need or a want?” and come up with subcategories they can live under for your budget. It’s also recommended that you round up your utility expenses to the nearest $5 to anticipate heavier usage months.

Once that’s complete, how do your expenses measure up to each category? Are there any expenses that you can potentially recategorize, or should you tweak the percentages to better fit your situation?

Next, identify easy, low-hanging opportunities to save. For example, do you have too many streaming services? Can you share accounts with your roommates, family or friends and split the cost 50/50?

Once you think you’re set, test-drive your new budget for 2-4 weeks to see if it’s livable. If a budget is not livable, you won’t stick to it, so it’s crucial you find a balance that will work for you beyond the short term.

If you need a place to start, I have a handy budget template you can use today. Just email me at info@torresmortgages.ca for a copy of the template. 

Let’s get budgeting

The 50/30/20 budgeting rule is an easy way to start your journey towards financial freedom. As your financial situation evolves, revisit your budget periodically to ensure it works for you through every stage of your journey.

Life can be unpredictable sometimes but even a little bit of financial planning can go a long way.