The 50/30/20 Budgeting Technique: The Good, The Bad & The Ugly
What is the 50/30/20 Budgeting technique?
The 50/30/20 budgeting strategy is a basic set of rules to follow to enable people to achieve their financial goals and better manage their finances. In her book “All Your Worth,“ Elizabeth Warren goes into a simple plan on how to divide your after-tax income and determine how to allocate where you are spending your money. Essentially, she states you’ll want to do the following:
- Spend 50% of your after-tax income on your needs.
- Spend 30% on your wants.
- And save the other 20%.
Easy enough right? The rules are simple but as we all know, being disciplined with your money is never as easy as it sounds. No matter your opinion of Warren, or budgeting, or this specific technique, try to keep an open mind and let’s discuss it.
The 50/30/20 budgeting technique is simple and intuitive to follow. Simple plans make it more likely that most people will be able to follow them. This technique does provide a way for people to achieve financial freedom and prevent themselves from getting into debt. This is a powerful motivator for most, as the majority of people will get into debt at some point throughout their lives. In fact, in America alone, over $14 trillion of debt was recorded in March 2020.
If you spend 50% of your after-tax income on your needs – obligations, bills, and debts – you will be freer from financial pressure at an earlier stage than if you only paid off a smaller percentage. Of course, this requires you to not live outside your means. You will need to make decisions based on your income (which we typically already do), like where you live, what kind of car you drive, and where you buy groceries.
We also like that 30% is for fun/wants. We are big believers that you need to enjoy life and if you work hard for your money, you should get to treat yourself. That’s a good chunk of fun every month. Any budget plan that doesn’t acknowledge that you should splurge a little, isn’t sustainable. What’s the point without a little leisure?
If you’re saving 20% of your income monthly, you’re doing a pretty good job. Most Americans don’t even have enough in their savings to cover a $500 emergency cost. Those savings can be allotted to different areas like retirement, emergency funds, college funds, or a down payment on a house.
All of this put together allows you to meet your needs, enjoy yourself, and put money back for big purchases. This means you are better prepared for emergencies, happier with your lifestyle, and better equipped to tackle retirement.
However, everything has a flipside.
The main problems of using the 50/30/20 budgeting technique are that it can be vague to follow at times, it doesn’t encourage early debt payoff and it is not sustainable throughout your entire life.
It is a very basic framework and the vagueness allows you to potentially hide poor spending habits. It encourages the thinking that you can purchase unnecessary products and services just because you have disposable income. If you have a high income, 30% of your after-tax income on anything you want can add up to a hefty, significant amount of money. This is money that could be spent elsewhere to improve your life or be invested.
If you are a low-income earner, spending 30% on wants could be detrimental and not allow you to get out of your low-income situation. All you would achieve is perpetuating your current economic level, without any wiggle room to help you improve your finances. The 30% rule may not work for the extremes on both ends of the spectrum.
The 50/30/20 budgeting plan also doesn’t enable you to pay off your debts faster, because you’ll be following this strict financial template. For example, say you decide you want to increase your monthly payment on your car so you reduce the amount of interest you contribute over time. Now you’re spending 60% on needs, and less in both the wants and saving category. We like that decision. We appreciate that you’re being money savvy and thinking ahead. We see this as a step closer to financial freedom. But technically this doesn’t follow the 50/30/20 plan.
Finally, this budget rule isn’t a long-term method of managing your finances. Reason being that it puts a lower priority on your savings. If you know that you may potentially have medical expenses, or other unexpected situations or emergencies, having savings gives you a financial buffer to prevent further debt. Your savings will improve your retirement prospects too, especially if invested correctly.
At the end of the day, the 50/30/20 budgeting technique is not the “one glove fits all” method of managing your finances that it is marketed to be.
Your lifestyle, your interests, your wants, and your needs are always in fluctuation. They change over time. There may be years where you’ll want to focus more on paying off your mortgage. Other years you’ll want to save more money because of a major life event. There may even be times where you’ll want to spend more than 50% on your living expenses. Life is always changing.
This is why we always emphasize that your financial plan has to be tailored specifically to you and your life. There will never be a budgeting technique or financial plan that works for everyone. It’s just not possible.
Putting It All Together
Our opinion is that it can be detrimental to follow a budgeting plan wholeheartedly without reflecting on your life, the way you spend money, and your personal finance goals.
Our advice is to try different plans, reflect on how they’ve worked for you, and adapt them to your unique situation. This is the only way to find out what works and what doesn’t.
If you’d like more information and advice on your finances, as well as tips, techniques, and methods of making money and becoming more financially independent, sign up for the newsletter and feel free to contact us with your questions – we’ll be happy to help.