MKS-14: The Business of the 21st Century 50-30-20 Rule to Financial Freedom

The 50-30-20 Rule. While we all define success differently, money is typically one of the factors in the equation.

Some people hope to become incredibly wealthy. Most want to achieve a degree of financial freedom, and the peace of mind that comes with it.

And then there is people don’t want to be rich. They want to be able to choose. The [more money you have], the more choices you have. That is the freedom of money.”

The 50/30/20 rule of thumb is a guideline for allocating your budget accordingly: 50% to “needs,” 30% to “wants,” and 20% to your financial goals. It was popularized by Elizabeth Warren and her daughter, Amelia Warren Tyagi. Your percentages may need to be adjusted based on your personal circumstances.

The 50-20-30 (or 50-30-20) budget rule is an intuitive and simple plan to help people reach their financial goals. The rule states that you should spend up to 50% of your after-tax income on needs and obligations that you must-have or must-do.

Sounds great.

But when you are barely making ends meet, achieving even a semblance of that kind of freedom also sounds impossible.

Where do you even start? A simple approach is to adopt the 50-30-20 rule of thumb for budgeting.

Let us break it down

If you implement the 50/30/20 rule properly it will help you spend less, save more, and reach your financial goals faster. Step 1: Figure out Your Take-Home Pay. The first step to using the 50/30/20 rule is to figure out your take-home pay, or after-tax income.

The 50-30-20 Rule: The Basics

Start by putting your monthly income (and spending) into three basic categories.

Needs: 50 Percent

Think of needs as relatively fixed costs. Housing. Utilities. Food. Clothing. Insurance. Debt payments (payments on things you already have, not on things you may finance in the future).

Needs are truly needs. Netflix is not a need. Starbucks is not a need. Food is a need but eating out is not a need. Current debt payments are, for now, a need since you need to make them.

Hold that thought because we will come back to it.

Wants: 30 Percent

Think of wants as desires. Entertainment. Hobbies. Vacations.

Anything you do not have to have to survive — even if some seem so important you cannot imagine doing without.

Keep in mind the easiest way to blow your budget is to mistake desires for needs. We all need to decompress, but how we decompress, and how much money we spend to relax and recharge, is a choice.

The same is true for “upgrades.” If I commute to work, I need a car. But I do not need, say, a Porsche. So, the upgrade portion of car expenses — and any other expenses — should go into the “want” category. Like eating out. We all need to eat. But we do not need to eat out; the difference in cost falls into the “want” category.

Or take fitness; I see staying fit as a need, but a $1,500 to $2,000 bike meets all my cycling fitness needs. I may want an $8,000 bike, but I do not need one. So, if I decide to buy a high-end bike, the extra $6,000 should go into the “want” category.

Granted, we all define “basic” needs differently. Plus, we all tend to ratchet up our expectations of “basic” as we earn more money. Or to think we “deserve” certain things.

But that is a slippery financial slope; if you consistently increase your spending to match your paycheck, you will never get ahead.

And find yourself wondering why.

Again: Be ruthless when you categorize “wants” and “needs.”

Financial Goals: 20 Percent

Emergency savings. Investments. Retirement funds. College funds. Paying off debt. (Not making minimum payments, but making additional principal payments, like adding an additional $50 to your credit card payment.)

If you are barely scraping by, this category probably has very few entries.

Putting the 50-30-20 Rule into Action

Once you have placed all your spending into categories, do the math: Divide the total of each category by your total monthly income.

Let us work through an example. The Census Bureau says the U.S. median income is just over $31,000. After taxes, that is a net of around $2,000 a month.

Using the 50-30-20 rule, $1,000 should go to needs, $600 to wants, and $400 to savings and paying down debt.

Granted, that is a tough ask. Taking care of housing, food, transportation, and other basic needs on $1,000 a month is daunting, if not impossible. So, your ratios may be different. Your “needs” money may take up the bulk of your income, and your savings percentage may be nonexistent.

So where should you start?

Take a hard look at your needs. Any item you can eliminate or reduce helps rebalance your ratios. Pay special attention to recurring expenses. Every year we shop for better insurance rates; every year we do a little better. (It is amazing how discounts suddenly appear when your business may be lost.)

Same is true for things like cable; call and say, “I think I need to cancel my cable subscription. It’s too expensive,” and the rep will magically find ways to cut your costs.

Take a close look at every need and see if there is a way to reduce, or work to someday eliminate, the cost.

Take a harder look at your wants. Right now, what you really need — and should really want — is to gain a sense of financial freedom. Short term, that will likely mean a little sacrifice.

But once you get through the period, barring unforeseen circumstances, you will never have to take such harsh measures again. Trust me: The tradeoff is worth it.

Be smart about savings. Financial experts love to say, “pay yourself first.” And you should. But sometimes paying yourself means paying off high-interest debt.

As Warren Buffett says, “If I owed any money at 18 percent, the first thing I’d do with any money I had would be to pay it off. It’s going to be way better than any investment idea I’ve got.”

So, if you have high-interest-rate debt, see paying it off as a form of investment — because it is. Putting an extra $100 toward a high-interest debt is like making 15 percent on that $100. And there is a bonus: Once that debt is paid off, the principal portion of the payment comes out of your “needs” category, making your ratios shift even more in your favor. 

The Bottom Line

Keep in mind the 50-30-20 rule is just a guide. If your income is relatively low and you have a big family, saving 20 percent may be a struggle.

If you are doing relatively well and want to put 20 percent down on your first home, “only” saving 20 percent may mean it takes a while to get there. (The median house price in Austin, Texas, is more than $400,000, which means you will need to save $80,000 just to cover the 20 percent down payment.)

That is why the real value of the 50-30-20 rule may be that it forces you to take a close look at what you spend — and at your short- and long-term goals. 

If you can generate more income, great: The more you make, the more money available to fund each category. Still, making more money is only partly in your control. You can get a part-time job. Or start a side hustle. Or work incredibly hard to increase your business’s revenue, or your income.

But there are only so many hours in the day. And building an extremely successful business takes time.

So, for now, the only way to have more money is to spend less money. Knowing when a need is actually a want. Knowing when an upgrade is a want, and not a need. Knowing that money you spend today is money you get back — and that putting money aside now is the only way to build wealth.

Knowing where, and how, you spend money — and making smart decisions about where and how to spend it in the future.

That is the only way to achieve at least some degree of financial freedom, and to enjoy the increased number of choices that come with it.

If you are seeking proven ways to financial freedom that you can do in as little as an hour a day contact us.

Michael Kissinger

Sydney Reitenbach

Phone: 415-678-9965

Email: mjkkissinger@yahoo.com