Should You Try the 50-20-30 Rule?
Like any financial rule of thumb, the particulars of this budgeting strategy may not fit every lifestyle and should therefore be looked upon as a guideline that can be tweaked to suit your individual circumstances. But, even if you customize it to work for you, the 50-20-30 rule can help you become a lifelong saver and put you on the path to prosperity.
What Is the 50-20-30 Rule?
The 50-20-30 rule is a basic budgeting guideline that can help you cover your day-to-day expenses while also planning for long-term financial goals. According to the rule, you should divide your net (after tax) monthly income into the following three parts:
- 50% for needs. This category includes your monthly rent or mortgage payment, property taxes, groceries, utilities, transportation (including auto insurance, if you drive a car), and all minimum monthly debt payments (e.g. car loans, student loans, lines of credit, credit cards, etc.).
- 20% for savings. This category is for funds that you sock away for the long term, including contributions to Registered Retirement Savings Plans (RRSPs), Registered Education Savings Plans (RESPs), Tax-Free Savings Accounts (TFSAs), non-registered accounts/investments as well as money you put toward paying off debts. Note that short-term savings—for a vacation or wedding, for example—would also be included in the category below.
- 30% for wants. This category encompasses all your discretionary expenses, such as entertainment (including cable and internet), eating out, vacations, parties/events, designer clothing, jewelry, tech gadgets, gifts, etc.
Keep in mind that one person’s desire may be another person’s necessity. For example, in some communities it’s impossible to get around without a car, while others have very good public transit systems that can eliminate the need for a car. Similarly, a smartphone with a data plan may fall into the “wants” category for some but would be in the needs category for those who are self-employed and must be accessible to client/customer calls and emails at all times.
Also note that the above percentages for spending on needs and wants are maximums, while the figure for savings is a goal. Obviously, if you’re able to spend less and save more, you will achieve your financial objectives that much sooner.
Reasons to Try the 50-20-30 Rule
If you’ve never sat down to figure out exactly where your hard-earned money goes, trying the 50-20-30 rule could be a real eye opener. You may be under the impression, for example, that your income is too low to allow for savings because you spend all your earnings every month. But, if you take a good hard look at your spending and discover that more than a third of your income is going towards wants rather than needs, that argument doesn’t really hold up.
On the other hand, if you find out that you’re spending more than half your income on necessities, it may be prudent to look at ways to reduce those expenses. For example, you may need to move to a city or town where housing is cheaper, find ways to make your home more energy efficient, or sell your car and rely on public transit.
You may also benefit from trying the 50-20-30 rule if you:
- Have difficulty prioritizing savings. It’s tough to put the needs of your future self ahead of your immediate desires. This universal trait known as “present bias” can be overcome by instituting a blanket rule of devoting 20% of your income to long-term savings. To hold yourself accountable, you could set up automatic bank transfers to your investment or savings accounts at the beginning of each month so you are not tempted to spend that money.
- Want to get out of debt. In order to make a realistic debt repayment plan, you must first track all your spending as compared to your income to see where savings opportunities exist. The 50-20-30 budget is a great place to start. In fact, if you have a lot of high-interest debt, you may even want to reduce your discretionary spending below the 30% threshold temporarily so you can channel more money into debt repayment. This will not only make you debt-free sooner but will also bring down your monthly debt-service costs in the “needs” category.
- Like the KISS rule. If you are a proponent of keeping it simple, then this budgeting technique is for you because it offers a clear path with no ambiguity. To make it even easier, you can use a budgeting app to help you track your spending, so your chequing account is never in the red.
Is the 50-20-30 Rule Practical for Everyone?
There are obviously some people who will have a great deal of difficulty saving 20% of their take-home pay, particularly those with low incomes who are just starting out (unless they are lucky enough to continue living at home with their parents for a few years to minimize housing costs).
If, however, you have an above-average income and still struggle to fit your spending and savings into these general guidelines, take that as your wake-up call to make some lifestyle changes.
Given that the average household saving rate in Canada is currently hovering around 1%, even a modified version of the 50-20-30 rule could go a long way toward improving your financial future. So, think of the rule as a starting point, or a goal to strive for, but feel free to adapt the percentages to work for your circumstances and stage in life.
How to Make the Rule Work for You
The most important part of any budget is tracking your spending to ensure you aren’t living above your means. To that end, if you find you need to spend 70% of your income on necessities at this time, perhaps you can save 10% and leave 20% for discretionary spending. That will still allow you to cover your day-to-day expenses and save for the future, while also having some “fun” money to enjoy in the present.
When you get a raise or find a better paying job, however, don’t succumb to “lifestyle creep” by upsizing to a larger home, getting a more expensive car or spending all that newfound cash on nice-to-haves. Instead, make a point of raising the percentage you save every month so you can pay down debt and provide for your retirement.
Regardless of whether you strictly adhere to the 50-20-30 rule or find another ratio of spending vs. saving that you can live with, you can’t go wrong with this easy-to-follow budgeting strategy. Once you start tracking where your money is going and devoting a certain percentage to the long-term, you’ll soon be that seemingly effortless saver who your friends admire.