What is the 50/30/20 budget rule?

This simple method may help you grow savings and pay off debts faster (iStock)

Let’s start with the bad news: Americans aren’t the best at saving money. Multiple recent surveys claim that the majority of U.S. adults have a meager amount in the bank for a rainy day. The good news? There’s no shortage of budgeting strategies that you can implement to build your savings and shore up your finances overall. One popular approach is the 50/30/20 budget rule.

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What is the 50/30/20 budget rule?

Coined by recent presidential candidate and Massachusetts Sen. Elizabeth Warren in her 2005 book All Your Worth: The Ultimate Lifetime Money Plan, the 50/30/20 rule is a simple way of managing your money where you divide your after-tax income into three categories: 50 percent to needs, 30 percent to wants, and 20 percent to savings and debt.

“Needs” encompass necessities, such as rent, mortgage, utilities, groceries and transportation. Under the 50/30/20 budget rule, half of your take-home pay should go toward these living expenses.

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“Wants” entail your discretionary expenses: things like dining out, shopping, vacations, or your Netflix account. Basically, anything that you’d like to spend money on but don’t really need.

“Savings” can be comprised of a savings account, IRA, 401(k), mutual fund account, or stocks, among other options. It also includes your “emergency fund”—a sum of cash that you set aside to cover at least three to six months’ worth of your basic living expenses in the event that you get laid off or suffer a financial hardship—and any debts that you can pay off, like credit card debt or student loans.

Warren’s 50/30/20 method gained steam because it’s straightforward to understand and easy to implement. You don’t need to be a financial planner to use this budgeting strategy.

How does the 50/30/20 budget rule work?

Ultimately the 50/30/20 approach boils down to one skill: discipline. Meaning you may have to curb some of your spending behaviors and free up enough cash flow in order for you to follow the guidance. It may sound trite, but cutting out small luxuries, like those $5 Starbucks coffees, can make a big difference.

Directing a portion of your income every month into a designated savings account automatically can ensure that you’ll meet your 20 percent savings goal every month.

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Also, consider using a free budgeting tool to track your spending across all of your financial accounts and identify areas where you can cut back.

Though working adults of all ages can use the 50/30/20 method, some financial experts say it’s not always a realistic approach for millennials who are already struggling to pay rent and keep up with their student loan payments. The average graduate from a public or private nonprofit four-year college was $29,000 in 2018, according to the College Board’s Trends in Student Aid 2019 report.

In addition, the 50/30/20 strategy may not be the right fit if you’re shouldering a large amount of high-interest credit card debt; in that instance, you may have to beef up your debt payments—and switch to a 50/10/40 approach—to pay down your debt faster and save money on interest.

How can you still follow the 50/30/20 budget rule with loans?

If your student loan debt—or any other form of debt—is eating up most of your income, there are ways you can change your lifestyle to follow the 50/30/20 budget rule. For example, if you live in a city with high rents, you might have to move home with mom and dad for a few months to save money. Or you could look into refinancing your student loans to obtain a lower interest rate. Even taking small steps, like cooking more meals at home, can lead to significant savings.