The 50/30/20 Rule: Setting Spending Targets

Too many Americans currently have no clue how they spend their money, but they know it feels like it flies out of their bank accounts faster and faster.  It does!  Americans have more and higher recurring costs than ever.  

We expect a rent or mortgage payment, but car payments are now higher and have longer terms, adding to our recurring monthly costs and leaving less spending money.  Beyond home and transportation, Americans spend years paying off their newest phone, and more and more choose to make nonessential purchases using Buy Now, Pay Later services that lock up more money for future months.  Add recurring Netflix, Amazon Prime, Disney+, Hulu, and Apple TV memberships, and the average American does not have a lot of money left over for nonrecurring spending.  But that spending adds up too!  A quick purchase from Amazon, stopping at Target for essentials, and getting drawn to the electronics at Costco when you only intended to buy groceries can easily make what little money you have each month disappear.

If the previous paragraph describes your current financial situation, you need a budget.  Since budget can be an evil word for so many, hear me out.  Budgets have a perception of being restrictive tools that prevent fun.  It is not true.  Budgets are tools to help you find more money for the spending you value most so you can maximize your fun.  Instead of not having enough money left over for your favorite activities, prioritize that spending in your budget so you can always do what makes you happy.

The 50/30/20 Rule

If you are new to budgeting, the 50/30/20 Rule is a common starting point.  The simplest explanation of the rule is:

• 50% of your take-home income goes towards your needs: This includes paying for a home, transportation, health insurance, and basic food.

• 30% of your money goes towards wants: This is the fun stuff.  It includes a morning stop at Starbucks or dining out, paying for anything related to your favorite hobbies, funding your shopping excursion, paying for the food to host a party, and more.

• 20% goes towards savings: This includes saving and investing for retirement as well as debt repayment.

For the budget novice, following a simple budget strategy like this will help immensely.  Start here to establish a basic understanding of your spending.  However, over time, this budget may not actually let you achieve your financial goals or retire by a particular age, depending on your current financial situation.

When 20% Savings is Enough

The 20% savings rate recommended in the 50/30/20 rule can be sufficient to meet your financial goals if the following is true for you:

1. You plan to retire 30 or more years in the future.

2. You invest all of that 20% savings.

3. You have no debt.

Those are some pretty stringent guidelines for generic advice, but that is the mathematical reality for the numbers.  A savings rate of 20% means you live off of 80% of your current income.  If you wanted to save enough money to live off of that same income in perpetuity, it would take 100 years to save enough money to maintain your lifestyle, assuming you are not investing!  If you invest instead, that 100 years drops to 30–31 years, assuming 7% returns annually on your invested money.

In other words, if you are exactly my age (I am 34 years old), have no debt, and do not mind working until a regular retirement age of 65, you can make the 20% savings rate work as long as you invest all the money you are saving.

If you are younger, you may have more options.  This is great because we would never advise investing all of your money.  At a minimum, you should have some kind of emergency fund.  You probably also want high-yield savings accounts (HYSAs) to save for spending goals other than retirement.  Additionally, you may need some money to pay off debt.  

To accommodate all those realities, the 20% guideline can work if:

• You plan to retire in 35 or more years in the future.

• You invest 15% of your money.

• The other 5% is sufficient to first save for an emergency fund, then pay off debt.

This works because saving and investing 15% of your money will allow you to retire in 35–36 years, assuming 7% returns.  The other 5% can help build an emergency fund, then pay off debt.  In reality, you can also probably get away with a slightly more generous split towards emergency fund contributions and debt reduction because a 15% savings rate assumes you live off of 85% of your income.  You actually live off of 80% since the other 5% goes towards debt.  If allocating 6–7% of this savings towards debt reduction allows you to pay off debt much more quickly, you can then catch up on retirement contributions once that debt is paid while still staying within this 20% savings rate.  In short, if you are younger than 30, you have the time and flexibility to work within this 20% benchmark even if you still need to save an emergency fund and/or pay off debt in addition to saving for retirement.

When 20% Savings is Not Enough

If you have less than 35 years until retirement and have debt, a 20% savings rate is not going to allow you to retire by age 65.  This is just math.  Here is our savings rate table to show why from Savings Rates Deep Dive: When Can You Retire?:

Savings Rate	Expenses	Years to Save One Year of Retirement Expenses	Number of Years of Expenses Saved in One Year	Years of Saving Required to Achieve FIRE (4%) without investing	Years of Saving Required to Achieve FIRE (4%) with 7% returns annually on investments
5%	95%	19.0	0.1	475.0	52–53 years
10%	90%	9.0	0.1	225.0	41–-42 years
15%	85%	5.7	0.2	141.7	35–36 years
20%	80%	4.0	0.3	100.0	30–31 years
25%	75%	3.0	0.3	75.0	27–28 years
30%	70%	2.3	0.4	58.3	24–25 years
35%	65%	1.9	0.5	46.4	21–22 years
40%	60%	1.5	0.7	37.5	19–20 years
45%	55%	1.2	0.8	30.6	16–17 years
50%	50%	1.0	1.0	25.0	14–15 years
55%	45%	0.8	1.2	20.5	13–14 years
60%	40%	0.7	1.5	16.7	11–12 years
65%	35%	0.5	1.9	13.5	9–10 years
70%	30%	0.4	2.3	10.7	8–9 years
75%	25%	0.3	3.0	8.3	6–7 years
80%	20%	0.3	4.0	6.2	5–6 years
85%	15%	0.2	5.7	4.4	4–5 years
90%	10%	0.1	9.0	2.8	2–3 years
95%	5%	0.1	19.0	1.3	1–2 years

To figure out what savings rate you need, start with your number of years until retirement.  The savings rate chart is age-agnostic: Use how many years you are from retirement to find your ideal savings rate.  For example, if you are 40 and want to retire at 65 years old, you have about 25 years until retirement.  If you have no retirement investments at this point, you need a savings rate of 30%.  If you are 40 but would feel more comfortable planning to retire at age 60, that works too, as long as you are willing to take on a more aggressive savings rate of 40%.

If you still need to build an emergency fund or have debt to pay off, you can factor this into your calculations as well.  Determine what percentage of your annual income you would ideally put towards savings or debt repayment.  For example, if you calculate that repaying your debt would take three years if you allocate 7% of your income towards debt repayment, and you want to retire in 25 years, start using the chart by identifying your ideal savings rate if you had no debt: A 30% savings rate would allow you to retire in 25 years.  A 35% savings rate would allow you to retire in 21–22 years.  Work in the middle to find a strategy that works for your debt repayment and retirement saving and investing: Choose a 34–35% savings rate overall, knowing that 7% would go towards debt for the first three years.  Maintain that savings rate and contribute all 34–35% to retirement after debt is repaid.

Where to Adjust to Cover a Higher Savings Rate

Everyone assumes that adopting a higher savings rate means reducing the 30% of your money that addresses wants, but it may actually come from the 50% of your money earmarked for needs.

The “needs” expense listed in the 50/30/20 Rule usually considers every penny of our largest expenses to be “needs.”  I disagree, but under this construct, I would advocate for reducing the “needs” portion of the 50/30/20 construct.  More specifically, most of us actually pay more than what we need for housing.  Take me as an example.  I need a home, yes.  I do not need to live within walking distance to both a baseball and soccer+ (that plus meaning rugby in recent years!) stadium.  I do not need to live in a building with a rooftop pool, grill, and gym that has everything I need.  I do not need a two-bedroom home for two people; we could absolutely live in a one-bedroom, and we did for years.  In other words, while I need a home, more than half of our mortgage actually covers wants that are included in living in a nice home.

I previously wrote how decreasing “needs” costs can have the biggest impact on our budget and the smallest impact on our happiness.  Most of us will better maintain our happiness levels if we opt to live in a slightly smaller home or drive an older car rather than cut out a hobby we enjoy or a dinner out with friends.  On top of that, adjusting these big expenses makes a bigger dent in our budget.  Cutting out dining out once a week may save $200 a month and decrease our joy, but opting for a used Honda Civic instead of a new Ford F-150 could save closer to $1,000 a month.

Of course, if you are using the 50/30/20 Rule because your spending is completely out of control, it may make sense to reduce some of your spending in the 30% “wants” category.  You should have a streaming service to entertain yourself, but you definitely should not pay for 5+ streaming services each month.  (My recommendation is to pick two and allow yourself to sign up for a third temporarily, like during playoffs for your favorite sport.)  If you spend $500+ on Amazon each month, outside of groceries, you may want to consider whether you are impulse buying and set a limit for yourself.  If you order takeout more than a couple times a week, consider whether preparing food at home would have an impact on your wallet and health.  If every Target visit ends with purchases that were not on the list, maybe limit yourself to one off-list purchase each visit.

But do not eliminate fun.  Keep spending on your favorite hobby.  Pay for the weekly indulgence that gives you the most joy.  See your friends and family, and make fun memories with them.  Just be intentional about the spending.  You will find that each dollar you spend goes a lot farther when you make sure to spend it on what you value.