Senator Elizabeth Warren popularized the so-called “50/20/30 budget rule” (sometimes labeled “50-30-20”) in her book “All Your Property: A Lifetime Money Plan“. The basic rule is to allocate after-tax income to expenditure: use 50% for demand, 30% for demand, and then save 20%. Here, we briefly introduce this easy-to-follow budget plan.
- Key points
- The 50-20-30 (or 50-30-20) budget rule is an intuitive and simple plan that helps people achieve financial goals.
- The rule states that you should use 50% of your after-tax income for needs and obligations that you must have or must fulfill.
- The remaining half should be allocated to 20% of savings and debt repayment, and 30% of other required funds.
- The rule is a template designed to help individuals manage their own funds and save for emergencies and retirement.
- The debt level of Americans is very high, as of March 2020, the total debt reached 14.3 trillion US dollars.
Needs are bills you absolutely must pay and are necessary for survival. These include rent or mortgage payments, car payments, groceries, insurance, health care, minimum debt payments, and utilities.
These are your “must-haves.” The “needed” category does not include redundant items such as HBO, Netflix, Starbucks, and dining out. Half of the after-tax income should be all that is needed to meet needs and obligations.
If you spend more money on demand, then you must either reduce demand or reduce your lifestyle, perhaps to a smaller house or an ordinary car. Carpooling or taking public transportation to work may be the solution, or more often cooking at home.
What you want is not that everything you spend on money is necessary. This includes dinner and movies, new handbags, sports tickets, holidays, the latest electronics, and super high-speed internet. If you boil it, anything in the “want” bucket is optional. You can exercise at home instead of going to the gym, cook instead of eating out, or watch sports games on TV instead of getting tickets to the games.
This category also includes upgrade decisions you make, such as choosing a more expensive steak instead of a cheaper hamburger, buying a Mercedes instead of a more economical Honda, or choosing whether to use an antenna for free or pay for cable TV. Basically, all these small additional expenses you spend will make life more interesting, wrote Elizabeth Warren in her book.
Finally, try to allocate 20% of net income to savings and investment. This includes injecting capital into emergency funds in bank savings accounts, making IRA contributions in mutual fund accounts, and investing in the stock market. In case you lose your job or an accident occurs, you should have at least three months of emergency savings.
After that, focus on retirement and achieve other financial goals. If emergency funds have been used, the first distribution of additional income should be to supplement the emergency funds account. Savings can also include paying off debts.
Although the minimum payment is in the “demand” category, any additional payment will reduce the principal owed and future interest, so it is savings.
Elizabeth Warren: Importance of Savings
As we all know, Americans have poor savings capacity and the country’s debt levels are high. As of March 2020, Americans’ total debt is $14.3 trillion, including $438 billion in credit card debt.
The personal savings rate in 2019 was 7.6%, down from 11% in 1960. Elizabeth Warren’s 50-20-30 rule is designed to help individuals manage their after-tax income, mainly with emergency funds and retirement savings on hand. Every family should give priority to setting up an emergency fund to prevent unemployment, unexpected medical expenses, or any other unforeseen monetary costs.
If emergency funds are used, the family should concentrate on replenishing funds. As individuals’ life spans increase, saving for retirement is also a crucial step. Calculate the cost of retirement from an early age and work towards this goal. This will ensure that you retire comfortably.
The Bottom Line
Saving is difficult, and life often brings us unexpected expenses. By following the 50-20-30 rule, individuals can make plans to manage after-tax income. If they find that their needs spend more than 20%, they can find ways to reduce their expenditures, which will help direct funds to more important areas, such as emergency money and retirement funds.
Elizabeth Warren says: “You should enjoy your life. It is not recommended that you live like a Spartan, but having a plan and sticking to it will allow you to pay for your expenses and save on your retirement pension, all of which will make you happy.”