A Smart Budgeting Tool: The 50/30/20 Rule
by Yuchen Wu, Student Blogger
Last weekend, I found a secret when I accompanied my friends shopping at the Flatiron Crossing Mall. Yingying is picky and she only wants to pay for the perfect apparel, whereas Cyril always opts for something affordable and doesn’t care about “perfection.” As a result, Yingying bought a $60 blue woven scarf while Cyril bought $30 jeans and some cheap T-shirts. While I was surprised about the two’s distinctive shopping philosophies, I started to wonder what their budgeting habits look like. What astonished me was that both of them felt that they only spend about 30 percent of their budgets on shopping.
It reminds me of the 50/30/20 rule, which basically states that 50 percent of one’s budget should be spent on “needs,” 30 percent should be spent on “wants,” and 20 percent should be saved. The rule is coined by a Harvard bankruptcy expert Elizabeth Warren and her daughter Amelia Warren Tyagi in their book “All Your Worth: The Ultimate Lifetime Money Plan.” My two friends, apparently, are fans of this rule and they are benefitting from it. So, I thought I should share this smart rule to help people with their money management.
Basically, the 50/30/20 rule outlines the following four steps:
Step One: Calculate Your After-Tax Income
In general, your budget is the amount you collect from all your paychecks after taxes. This after-tax income will be how much you can spend.
Step Two: Limit Your Needs to 50 Percent
A need is any payment that would severely impact your quality of life, such as housing, insurance, utilities, and groceries. According to the rule, spending on the “needs” should be no more than 50 percent of your after-tax income.
Step Three: Limit Your Wants to 30 Percent
A want is any payment that you can forgo with only minor inconvenience, like beautiful shoes, a movie, or a trip to Paris. Sometimes you will buy a “want” that upgrades to a “need.” For instance, you want to have a faster speed of internet or an upgraded cable bill. Although 30 percent sounds great, you may spend more on “wants” than you think.
Step Four: Spend at Least 20 Percent on Savings and Debt repayments
According to the 50/30/20 rule of thumb, you should spend at least 20 percent of your after-tax income paying your debts repayments, such as credit card balances, or saving money for emergency use.
All in all, where and how much to spend money is a deeply personal thing, but knowing this simple “rule” can help with your money management!
July 2nd, 2014