In personal financial planning circles, a budgetary principle known as the “50/30/20 Rule” has been making the rounds for some years. The term was first coined in the bestselling book, “All Your Worth: The Ultimate Lifetime Money Plan”, penned by Massachusetts Democratic Senator Elizabeth Warren and her business consultant-daughter Amelia Warren Tyagi, written when Senator Warren was a bankruptcy law professor at Harvard Law School.
Billed as a “lifetime strategy”, Senator Warren writes of the rule: “It isn’t based on a quick fix. It isn’t a cheap paint job on a crumbling old house or a crazy crash diet. This plan makes sense when you are 20 and when you are 80.” Of course, this rule is apt to particularly resonate with millennials and other individuals short on surplus cash.
How it works
The 50/30/20 Rule essentially carves out your total monthly household income into three distinct silos: Needs, Wants and Savings.
- 50% of your household income goes toward basic necessities such as car payments, rent, mortgages, utilities and groceries.
- The next 30% goes toward “nice-to-have” extras, such as fine dining, premium cable television, concerts, gym membership and vacations.
- The final 20% goes directly towards savings and/or investments—401(k)s, IRAs and the like.
Los Angeles financial planner Sam Rad is a believer. “I call this system ‘Fixed, Fun and Future’, because 50% of your income is for fixed costs, 30% goes towards the ‘fun’ things you have control over, and the last 20% is for what I call ‘the future’.”
Rad sub-divides the last category into “frugal” investments, to denote vehicles like annuities, bonds and money market accounts, and “fancy” investments, referring to things like commodity, currency, and option plays.
“The younger you are, the fancier you can be, because you have more time to recover from mistakes before you retire. The older you are, the more prudent you’d better be, because you’ll have less of a chance to make up errors, if you fumble,” advises Rad.
But not everyone rigidly subscribes to the 50/30/20 Rule. Financial planner Jen Mulder believes the 50% fixed-cost portion of the allocation verges on too low of a figure—especially for those living in expensive cities like Los Angeles and New York.
“It’s pretty hard to meet the goal of only spending 50% of your income on the absolute necessities,” Mulder opines. “It’s nice to shoot for, with the realization that you’re probably not going to get there until you’ve moved up the career ladder and your earnings are a bit higher.”
Mulder employs a more individualized approach to financial planning, which entails going through a client’s bank accounts and credit card statements, to suss out which recreational expenditures can be cut or reduced.
“I’m definitely an advocate of enjoying the day. But it’s also important to put something away,” says Mulder. “If you get into the habit of saving at least a portion of your income now, that habit will carry you through the rest of your life, and it will be the basis of a strong financial plan.”