Managing your finances can often feel overwhelming, especially when it comes to budgeting. You might, however, have heard of a straightforward approach known as the 50/30/20 rule, which can make budgeting easier and more effective. This rule provides a clear framework for dividing your after-tax income into three primary categories: needs, wants, and savings. At the end of each month, you can review your purchases and compare your spending against your income to determine how you managed against your budget, using any leftover funds for savings or debt repayment. By following this method, you can maintain a balanced and sustainable financial plan. Here’s a detailed look at how the 50/30/20 rule works and how you can apply it to your own budget.
What is the 50/30/20 rule?
The 50/30/20 rule simplifies budgeting by dividing your after-tax income into three main categories:
- 50% for needs
- 30% for wants
- 20% for savings and debt repayment
The 50/30/20 rule, conceived in 2005, sets out the principles of budgeting and shares some simple guidelines for balancing your budget between saving and spending. Let’s delve into each category to understand which expenses fall under each bucket, and how you can allocate your income effectively. It’s important to use these calculations based on after-tax figures, so you should figure out your after-tax income (once your pension plan, Employment Insurance, etc have been deducted) and then apply the percentages accordingly.
50% for needs
The first half of your income should go towards essential expenses that are necessary for your day-to-day living. These are non-negotiable expenses that you must pay to sustain a basic standard of living, and unlike wants, can’t be removed from your budget easily. Common examples include:
- Housing costs: rent or mortgage payments, property taxes, and insurance.
- Utilities: electricity, water, gas, and heating.
- Groceries: basic food and household supplies.
- Transportation: car payments, fuel, public transit, and insurance.
- Healthcare: insurance premiums, medical bills, and prescription medications.
- Minimum debt repayments: you’ll need to make these each month, else your credit score could be negatively impacted and lead to further consequences.
By keeping these essential expenses within 50% of your income, you ensure that your basic needs are met without compromising your financial stability.
30% for wants
The next 30% of your income can be allocated to discretionary spending or non-essential expenses. These are the things that enhance your lifestyle but aren’t strictly necessary for your survival. Examples of wants include:
- Dining out: restaurants, cafes, and takeout.
- Entertainment: movies, concerts, streaming services, and hobbies.
- Travel: vacations, weekend getaways, and related expenses.
- Shopping: clothing, electronics, and other personal items.
- Gym memberships and subscriptions: fitness clubs, magazines, and subscription boxes.
Spending on wants should be done mindfully, ensuring that these expenses do not encroach on the funds allocated for your needs and savings. You might also want to look through these and consider any purchases that you can cut back on each month.
20% for savings and debt repayment
The final 20% of your income should be directed towards your financial future. This includes both savings and debt repayment. Key areas to focus on are:
- Emergency fund: building and maintaining a fund to cover unexpected expenses or emergencies.
- Retirement savings: contributing to retirement accounts such as RRSPs, RESPs, or TFSAs.
- Investments: investing in stocks, bonds, or other investments to grow your wealth.
- Debt repayment: paying down more than the minimum payments on credit card debts, student loans, car loans, or any other outstanding debts.
Prioritizing your savings and debt repayment helps to secure your financial future and can lead to greater financial freedom and security.
How to implement the 50/30/20 rule
Implementing the 50/30/20 rule is relatively straightforward. Here are the steps to get started:
- Calculate your after-tax income: determine your total monthly income after taxes and deductions.
- Break down your expenses: categorize your monthly expenses into needs, wants, and savings/debt repayment.
- Allocate your income: assign 50% of your income to needs, 30% to wants, and 20% to savings and debt repayment.
- Monitor and adjust: regularly review your budget and make adjustments as you need to stay on track.
What are the benefits of the 50/30/20 rule?
The 50/30/20 rule is a great way to budget simply and keep your finances on track. Here are some of the key benefits:
- Simplicity: the rule is easy to understand and implement, making budgeting accessible for everyone.
- Flexibility: it allows for personal preferences within the categories, providing a balanced approach to spending and saving.
- Financial health: by promoting savings and controlled spending, the rule helps build a strong financial foundation and encourages debt repayment.
Who can benefit from the 50/30/20 rule?
The 50/30/20 rule is a good budgeting strategy for the majority of Canadians earning an average wage, although the principles can apply to anyone. If you have a limited income, you might find this isn’t possible. In some instances, your needs and wants may take up a larger portion of your net income. If you have a month where you think that sticking to the rule won’t be feasible, don’t panic – if it’s temporary, simply make a plan to try and catch up once your finances are more stable. If you’re a high earner, the 50/30/20 rule may not work for you either, since your net income will be higher and you’ll have more money to put towards savings or debt repayment than the average earner.
A 50/30/20 rule example in action
Here’s a working example of the 50/30/.20 rule. Say your after-tax, take-home pay is $4,000 each month. Given the laws of the 50/30/20 rule, your needs/wants/savings should look as follows:
- Needs: $2,000
- Wants: $1,200
- Savings and debt repayment: $800
In reality, this could look something like this:
Needs
| Need | Cost |
| Rent | $900 |
| Insurance | $100 |
| Utilities | $200 |
| Car payment | $200 |
| Fuel | $100 |
| Cell phone | $100 |
| Prescriptions | $50 |
| Groceries | $200 |
| Minimum debt repayments | $150 |
| Total | $2,000 |
Wants
| Want | Cost |
| Dining out | $250 |
| Takeout coffees | $50 |
| Entertainment | $200 |
| Travel | $350 |
| Shopping | $200 |
| Subscriptions | $150 |
| Total | $1,200 |
Savings and debt repayment
| Saving or debt repayment | Cost |
| Emergency fund | $100 |
| RRSP contributions | $100 |
| Car repayments | $200 |
| Credit card debt | $250 |
| Student loan | $150 |
| Total | $800 |
The 50/30/20 rule: FAQs
Here are some of the most common questions we’re asked about following the 50/30/20 rule:
What is the savings rule in Canada?
The savings rule in Canada, more commonly referred to as the ’50/30/20 rule’, is a guideline for managing personal finances. It suggests allocating 50% of after-tax income to necessities such as housing, groceries, and transportation, 30% to discretionary expenses like entertainment and dining out, and 20% to savings and debt repayment. This rule helps you to maintain a balanced budget, ensuring essential expenses are covered while still allowing for some flexibility in spending and prioritizing financial goals like building an emergency fund, saving for retirement, or paying off debt.
How effective is the 50/30/20 rule?
The 50/30/20 rule is generally effective as a straightforward, adaptable framework for budgeting that promotes financial stability and discipline. Its simplicity makes it accessible to a wide range of Canadians, helping them to prioritize essential expenses, control discretionary spending, and focus on savings and debt repayment. By offering clear guidelines, it helps to maintain a balanced financial approach and can be particularly helpful for those new to budgeting. Its effectiveness, however, can vary based on individual circumstances, such as income level, cost of living, and personal financial goals. While it provides a solid starting point, it may need to be adjusted to fit specific financial situations and objectives.
What is the 50/30/20 rule for high earners?
For high earners, the 50/30/20 rule can be modified to better suit their financial goals and lifestyle. While the basic principle remains the same – allocating a portion of income to necessities, discretionary spending, and savings – the percentages can be adjusted to reflect higher income levels and potentially greater financial flexibility. High earners might find it beneficial to allocate a smaller percentage to necessities, given that these do not typically scale proportionately with income, and a larger percentage to savings and investments. For example, a high earner might adopt a 30/30/40 rule, dedicating 30% to necessities, 30% to discretionary spending, and 40% to savings, investments, and debt repayment. This adjustment can help them build wealth more effectively and prepare for long-term financial goals.
Is 50/30/20 based on gross income?
No – the 50/30/20 rule is based on after-tax, or net, income rather than gross income. This means that the percentages are calculated using the income remaining after taxes have been deducted. Using net income provides a more accurate picture of the money available for essential expenses, discretionary spending, and savings or debt repayment. By focusing on after-tax income, you can create a budget that realistically reflects your financial situation, ensuring you allocate funds in a way that is both practical and sustainable.
Is the 50/30/20 rule a good idea?
Yes! The 50/30/20 rule is generally considered a good idea for many people because it provides a simple, easy-to-follow framework for managing personal finances. By dividing after-tax income into three categories – 50% for necessities, 30% for discretionary spending, and 20% for savings and debt repayment – it encourages a balanced approach to budgeting. The rule helps ensure that essential expenses are covered while also promoting savings and responsible spending. However, its effectiveness can vary depending on individual financial situations, cost of living, and personal goals. While it serves as a useful guideline, it may need to be adjusted to better fit specific needs and circumstances.
The 50/30/20 rule is an effective and simple budgeting strategy that can help you manage your finances more efficiently. By dividing your income into needs, wants, and savings, you can maintain a balanced budget that supports your current lifestyle while securing your financial future. If you’re concerned that it won’t work for you, or if you have unmanageable debts that you’re struggling with, book a free consultation with Spergel, the ‘get rid of debt’ people today, and we can help.