When it comes to managing your money, regardless of how much you earn, there is nothing more important than the 50/30/20 rule. I wish I came across this in my younger years, but I didn’t see this until after I was married with two kids.
The 50/30/20 rule all began with the amazing Elizabeth Warren. She was a law professor at Harvard University, and her specialty was bankruptcy law. She later went into politics, and a few years ago, she became the first female senator from the state of Massachusetts.
But it’s not her politics I wanted to talk about here. It’s the book she co-wrote with her daughter back in 2006. The book was called All Your Worth: The Ultimate Lifetime Money Plan. When it comes to finances, this book will change your life. I know a lot of people say that about all types of books, but believe me. This will be the only book on finances that you’ll really need.
For now, the thing to take away is how the book laid out the 50/30/20 rule. The rule has to do with financial balance. Think of all the things you spend money on in any given month. Groceries, movies, cell phone payment, cable TV, car insurance…it all adds up. But the thing is that everything you pay for exists in one of these three categories:
- Needs: the essentials in your life. Only four types of expenses should really go in this category. They are groceries, housing (rent/mortgage), utilities, and transportation.
- Wants: the lifestyle choices. These are things you pay for to enhance the quality of your life. Cell phones, cable TV, Netflix subscriptions, fast food, shopping, and other entertainment.
- Savings: the financial priorities. These are the things that help build your financial foundation including saving for an emergency fund, paying down debt, and saving for retirement.
The book suggests balancing your take home pay using the 50/30/20 rule. A maximum of 50% of your take home pay should go to the needs category. If you’re spending more than 50% on essentials, then you’re setting yourself up for future problems. The people who struggle financially living paycheck to paycheck are probably spending way more than 50% on the essentials. The way to rectify that situation is to either increase the take home pay or re-evaluate the items in this category. There are many things we call essentials but are really wants. (For example, is a cell phone a need or a want? What about a car payment or television?)
Approximately 30% of your take home pay should go towards your wants. This ensures that you’re not just paying for life, but that you’re actually enjoying your life on a regular basis. Supporting your lifestyle is important, but it shouldn’t happen at the expense of your needs or your savings. Support your lifestyle, but do so with a sense of balance and forethought.
Approximately 20% of your take home pay should go to building a solid financial foundation for your life. If you have debt, use this monthly 20% to begin eliminating it. When your debt disappears, use this monthly 20% to build an emergency fund (something I already wrote about last summer). When your emergency fund is built, use this monthly 20% to fund your retirement accounts.