You know that saving for your retirement is something you should do, but getting started is tough. Not knowing the answer to important questions like how much you should save can leave you frozen. Before you know it, years have gone by and you've saved very little.
If you've found yourself in this predicament, this popular savings rule could be the trick you need and get the ball rolling.
Image Source: Getty Images
What is the 50/30/20 rule?
The 50/30/20 rule makes budgeting simple. Rather than chronicling each dollar that you spend in a spreadsheet, this process buckets your take-home pay into three categories: needs, wants, and saving. In the rule, 50% of your income is used for things that you need like paying for your home, 30% is spent on things that you want like dining out, and the last 20% is directed toward saving for your retirement (or paying down debt, particularly high-interest debt like credit card balances).
How does the 50/30/20 rule work?
As an example, take someone whose after-tax take-home pay is $76,000. Using the 50/30/20 rule, $38,000 of income would go toward essential bills and $22,800 would pay for discretionary expenses, leaving $15,200 in savings for retirement. If you saved this much for 25 years, earning 7% on average every year, your account would grow to $1,028,682.
50/30/20 rule pros
Implementing and using this rule is very easy. It even makes accounting for your pay raises straightforward. For example, if your after-tax take-home pay increases to $84,000, there's no guesswork involved about how much of it you should allocate to each category. Now, your living expenses increase from $38,000 to $42,000 each year. You can splurge on nonessentials by spending $25,200 instead of $22,800, and your savings each year would increase to $16,800 from $15,200.
It also gives you a lot of flexibility. If in a given year, you choose to spend all of your discretionary income on a trip, you can. If you decide to live in a small house but drive a luxury car, that's completely OK. You can spend your money pretty much any way you want as long as you stay within your categorical budgets.
50/30/20 rule cons
One of the main flaws in this system is that it assumes that everyone's situation is the same. If you live somewhere expensive like New York or California, keeping within the 50% essential-needs budget could be harder than if you lived in a less expensive place like Mississippi or Oklahoma. Your rent or mortgage alone could account for 50% of your after-tax income in some pricier locations.
This rule is also geared toward people who are in higher income ranges. If for example, your take-home pay is $38,000, then your essential spending is limited to $19,000 a year or $1,583 each month. You can spend $11,400 each year on your wants and $7,600 on saving. You might find living off of $1,583 each month hard and end up filling in the gaps in need with either your discretionary budget or your savings. Saving $1,000,000 will also take a lot longer, and you'll need to start saving at an earlier age, work longer, or reassess your ultimate retirement savings goal downward if you make less money.
You can also limit yourself by basing your goals on a blanketed system instead of making them specific to your individual situation. If you are in the scenario where your after-tax take-home pay is $76,000 but only spend $15,000 on discretionary items, this rule would suggest that you spend the remaining $7,800 on things that you want rather than saving the rest.
Nevertheless, if you are someone who doesn't save because you're unsure where you should start, the 50/30/20 rule could give you the push that you need. Using it is simple and easy, and it can help you form great budgeting habits. Most importantly, it can get you on the right track for saving for your retirement.
