Every budget begins with the process of reviewing your transactions and tallying up what you daily spending on essentials like housing and transportation. Once you have these amounts totalled for the month, you can compare them against your income to determine whether you have a budget surplus or deficit and allocate the leftover money to savings and debt repayment. But how do you know if you’re spending too much (or too little) on everyday essentials? How do you know if what you are putting enough money away for savings, or debt? There are plenty of basic budgeting guidelines available, but one of the most intuitive and easy to follow is the 50/30/20 budget rule.
This easy-to-use budgeting rule was coined by Elizabeth Warren, a U.S. Senator from Massachusetts and 2020 Presidential Candidate. The term first appeared in the book that Warren co-authored with her daughter Amelia Warren Tyagi, All Your Worth: The Ultimate Money Plan. The 50 30 20 budget sets out easy to follow guidelines to balance your budget between spending and saving. Here’s how it works.
What is the 50/30/20 Rule?
The 50/30/20 rule is a simple way to organize your spending. To follow this rule, you need to spend 50% of your net income on needs, 30% on wants, and 20% on savings. You should allocate these percentages in after-tax dollars, which means you’ll need to calculate your after-tax income.
Your after-tax income is the amount of money you take home after taxes, Canada Pension Plan, and Employment Insurance are deducted. If your employer deducts money for retirement contributions, include that in the savings section of your budget.
Any expense that you require to survive is considered a need and shouldn’t total more than 50% of your after-tax income. Most needs are expenses related to food, shelter, and transportation to and from your job. Needs are different from wants in that you can’t cut them out of your budget without major inconvenience.
For example, cable TV is a want, because you could cut it out of your budget, and it would not severely affect your quality of life. On the other hand, your electricity bill is a necessity, because you can’t simply cut this item out of your budget without it severely impacting your day-to-day life.
A commonly forgotten need is debt. While you don’t need debt in your life (in fact, it should be a priority to live debt-free), it’s still a need because you have to make your minimum debt payments every month. If you don’t, your credit score will be negatively impacted, and you could end up with creditors hounding you.
Note that we said “minimum” debt payments. If your credit card’s minimum payment is $100 per month, but you make a point of sending $500 per month towards that debt in hopes of paying off your credit card debt fast, then only count the minimum payment as a need, since you need to make that payment. The rest can be counted in the savings and debt category.
Here are some additional examples of needs:
- Mortgage and rent
- Car payment
After your needs are categorized, the next section of your spending falls under the “wants” category. 30% may seem like a generous allocation for everything you want in life, but once you add up your spending, you’ll realize that you spend more on your wants than you might think.
Take a moment to consider all of the items and services you spend money on every month that you don’t need — items like your morning Starbucks coffee, and services like your Netflix subscription. Even your unlimited text messaging plan is a want and should be categorized accordingly.
Even items like expensive haircuts and decent clothing should be considered wants, because they go above and beyond the minimum you need to survive.
Savings and Debt: 20%
The final category is savings and debt. This category should include any debt payments that are beyond the minimum payment, as well as emergency fund contributions and long-term retirement savings contributions. Some examples of expenses that belong in the savings and debt category include:
- RRSP contributions
- TFSA contributions
- RESP contributions
- Emergency fund savings
- Extra debt repayment (or “pre-payments”)
Who is the 50/30/20 Rule For?
The 50/30/20 is ideal for Canadians earning an average wage. If you are living on a reduced income – for example, a member of your family is not working due to parental leave or critical illness – your budget might not fit these categories because your wants and needs will take up more of your net income. If your earnings reduction is temporary, don’t stress out about not saving much initially, but make a plan to catch up once your income stabilizes.
If you are a high earner, this budget system may not work for you either, since your net income will be higher and you’ll have more money to put towards savings than the average earner.
An Example of the 50 30 20 Budget in Action
It’s easy to outline each category, but let’s take a look at an example of a balanced 50/30/20 budget. Let’s say your take-home pay is $3,300 every month. Based on the 50/30/20 rule, you should allocate the following amounts to the major three categories.
- Needs: $1,650
- Wants: $990
- Savings and Debt: $660
Here’s an example of how this balanced budget would look:
|Savings & Debt Repayment|
|Extra car payment||$100|
|Emergency Fund Savings||$100|
What If Your Budget Doesn’t Fit the 50/30/20 Rule?
If you’ve prepared your budget according to the 50 30 20 budget rule, and you’ve found that your spending doesn’t conform to the suggested percentages, don’t panic. There may be reasons that your spending doesn’t match the categories as we’ve outlined above, or you may need to make some budget tweaks.
If you find that you’re overspending in certain areas, take steps to reduce your spending slowly, over several months. As you reduce your spending in certain categories, reroute that money to the categories that are unfunded. To prevent overspending, you could also look at using a prepaid debit card like KOHO (which is free and even gives you cash back on card purchases). Eventually, your budget will balance.
Another tip that will help reduce your spending is to look into budgeting and rewards apps. A cash back app like Ampli can really help stretch a dollar in unexpected ways. This new rewards app puts cash back in your pocket when you shop at eligible retailers (like Pet Valu, Best Buy, Indigo.ca, WestJet, Petro Canada and more). You just download the app and link your debit and credit cards and then make a qualifying purchase at a participating merchant. Money is automatically added to your account and you can cash out with a minimum of $15. It’s an easy, passive way to earn cash and the savings on your shopping can really add up fast.
Is the 50/30/20 Rule A Good Idea?
The 50/30/20 rule is an excellent budgeting strategy for beginner budgeters and will help you ensure you are prioritizing savings without overspending in other categories. It’s easy to implement too: simply tally up your savings, and make the necessary adjustments to ensure your wants, needs, and savings are in balance. You’ll be a super saver before you know it.