Hosted By: Wyatt Yates
Money Myth: 50/30/20 Budget Rule
In this episode, we discuss the 50/30/20 Budget Rule. What is this budgeting rule? Where did it come from? Should you follow this budget rule when doing your budget? What do you need to consider when you are making your budget?
1) Compare your current monthly budget to the 50/30/20 budget principle. How does your current budget compare? Are you over or under in one of the three categories?
2) Look at your current budget. Does it reflect your financial goals? Where do you need to make adjustments to your budget to have it keep you on track toward your financial goals?
Wyatt Yates Host 00:00 Money doesn't have to be complicated. You can achieve financial independence. This podcast gets to the truth behind the money mess you hear from your grandma, your broke uncle, the latest social media influencers and the so-called money experts. Welcome to Money Myths with your host, wyatt Yates. 00:23 This week's myth is the 50-30-20 budgeting rule. So first let's talk about what this budgeting rule is, where it comes from, maybe, why it could be a good thing, and then look at why it may not be the best way to do it. So the 50-30-20 budgeting rule looks at how to budget your after-tax dollars, so your take-home pay if you're an employee that works somewhere. So the 50% it says needs to go towards your needs or your essentials, and in that category includes housing, groceries, transportation, insurance, minimum debt payments, etc. Basically what your needs and essentials are. Then for the 20%, that's your savings and investing and debt payments. So think you're saving for your emergency fund or retirement contributions or debt repayments above your minimum payments. So that's the 20% category. And then the 30% category is your wants, your non-essentials. So clothing, dining out, subscriptions, vacations, entertainment, etc. Anything that's a want or a non-essential. So that's the breakout 50% of your after-tax dollars goes to needs and essentials. 20% goes to savings, investing and extra debt payments, and 30% goes to your wants or non-essentials. If you Google this budget in rule, you're going to find it all over the internet, so let's look at where it actually originated from so that gives us some insight into you know, maybe, whether we should listen to it or not. 02:18 So this budgeting rule originates from Senator Elizabeth Warren's book All your Worth the Ultimate Lifetime Money Plan, which was published in 2006. She worked on this book with her daughter, now Senator Elizabeth Warren. Before she was a senator, so 2006, when this book was published, she wasn't a senator yet. Prior to becoming a senator in 2013, warren was a law professor with expertise in bankruptcy law. She authored several books and she even served as a special advisor for the Consumer Finance Protection Bureau under the Obama Administration, so she knows a lot about bankruptcy. That's her expertise. Not really a personal finance expert in terms of not a financial advisor, financial plan or anything like that. She was a professor, didn't work with people. So when you know where this originated from, you start questioning it a little bit. This isn't somebody that came up with it that has spent their life dealing with personal finance or worked with hundreds or thousands of people in helping them through their personal finances. This is a law professor that specialized in bankruptcy law, that wrote a book, but this has gained a lot of traction as far as this budgeting rule. So why has it gained traction? 03:46 I mean, there are some good things with this budgeting rule. First, it's a good starting point. If you're not budgeting, it can be really hard to understand well, how much should I be spending in different categories. So this as far as what I like about this budgeting rule and why it may be true this is a very good starting point for somebody just starting out. The other thing that I really like about it, the second point that I really like about it is it forces you to think about your needs versus your wants. That's a critical step when you're budgeting is what's really a need and what's a want, and deciphering between those two will help you make some financial decisions to reach your goals. And the third thing I like about this is it is better than not having anything and not having a budget. Having a budget is better than not having one, as we discussed in previous episodes. Now let's look at some of the reasons why this budgeting rule could be false, or some of the flaws in this budgeting rule. So I had three reasons why I like this budgeting rule. 04:56 I have seven why I don't like it and I could probably come up with more, but we're going to stick to my top seven. The first one is this is very vague With having just these three categories. It makes it very easy to hide bad spending habits and unnecessary purchases. You're painting a broad brush with just three categories and you can very easily hide those, and it's even vague on your wants versus your needs. For example, housing is in the needs category. However, even with housing, there's a difference between wants and needs. You need a roof over your head, but you don't need your dream home. So that's the first point. It's too vague, it makes it easy to hide bad spending habits or unnecessary purchases, and it's even vague on your needs versus wants. 05:55 For the second point why I don't like this is it doesn't favor debt payoff. Right, surprise, a bankruptcy attorney developed something that doesn't favor debt payoff, so it puts your minimum debt payments into your need category. Guess what? You don't need debt. There's millions and millions of people across the world that have zero debt. Even in the US, there's millions of people that have zero debt. Debt is not a need. So that's the first flaw. 06:25 And if you have a lot of debt, 20% of your budget for saving, investing and extra debt repayments is not enough to make meaningful progress in getting out of debt. When my wife and I paid over $300,000 in debt in two years we were doing 50, 60, some month 70% of our income was going towards paying off the debt. You know the same goes with a lot of the clients I work with. You can't just dip your toes in the water with getting out of debt. You have to go all in or you will never be debt free and you're always going to be a slave to someone else. So this doesn't favor it. This is a little dip of your toes in the water. Try to slowly make progress and not really attack getting out of debt. And it's a major flaw because this is one of the things that holds the people back the most is being consumed by debt. 07:26 The third flaw with this budgeting rule is it doesn't account for different stages of your life. So when you're younger, you should be really attacking paying off any debts if you have debt and saving and investing. But when you're older and in retirement, the 20% in savings no longer applies. You've done the work, your allocation for savings will decrease and your wants and needs will increase. So, based off where you are in your life, your budgeting and what you're spending your money on, or in saving or investing, is going to vary drastically, and this budgeting rule does not account for that at all. The fourth flaw with this is it doesn't account for different income levels. So the lower your income is, guess what you have, less wants that you can afford. The higher your income, the lower your needs are gonna be, and the higher your saving and investing is, so your income level will affect how you can budget and what you can afford. So in this budgeting principle does not account for that at all. The fifth flaw with this method is it doesn't account for when you started to save and invest for retirement or when you want to retire. 08:40 The earlier you start to save for retirement and invest for retirement, the less percentage of your income you're gonna have to invest, assuming you work the same amount of time before you're gonna be able to retire. So let's just walk through an example. Let's say you start saving at age 25 and you only make 30 grand a year for your whole working life. You never get any raises. You just make $30,000 a year, starting at age 25. But let's say you contribute 15% of your gross income towards retirement when you reach age 67. So 42 years of working, you will have over a million dollars. If you put in 15% of your retirement, that's assuming a 7% return. Now you may get more than that, you may get less, but 7% is a very conservative rate of return assumption in this scenario. So if you start early age 25, you only have to do 15% if you're making 30,000 a year. So when you start and when you want to retire drastically affects how much you need to allocate to your savings and retirements. The later you start, the higher percentage of your income you're gonna have to invest to be able to retire. The longer you work, the less you're gonna have to save as a percentage of your income. The less you work, the more you're gonna have to save as a percentage of your income. So you have to look at when you want to retire, when you started saving and that is gonna affect your budget and what you need to allocate towards that. 10:17 The sixth flaw with this method is it doesn't account for your financial goals. So your budget is your vehicle. For you to reach your goals, you need to Taylor your budget to fit your financial goals. You can't just use a broad financial approach. Your budget has to reflect what your financial goals are or you won't achieve them. If you had a goal to run a marathon, you're not gonna go jump in the pool and start swimming laps To train for your marathon. You're gonna tailor your training towards your goal. You're gonna be out there running. You're gonna maybe get a coach. You're gonna buy a running program or follow a running program. The same goes with your budget and your financial goals. Your budget has to be tailored towards your financial goals For you to be able to achieve them. It is what drives you to achieve your financial goals. 11:13 The seventh flaw of this budgeting rule is that you are paying the government more than you're paying yourself. So I'm just gonna walk through an example using the 2020 average household income in the United States to give you an idea on how much you're paying the government in Terms of percentage your income versus what this budgeting rule is telling you to pay yourself. So the average household income in 2020 across the US was just shy of $98,000 a year. Now you can use this example for your personal situation and just Add up what you personally are spending as a percentage of your income. But let's look at this so Based off that most of people are employees, so a small business owner would be a little bit different. 12:02 But as an employee, you are paying what they call payroll taxes or FICA taxes, which is Social Security in Medicare in the US. Now, fica taxes or payroll taxes Social Security in Medicare for the average household income is 15.3% of your gross income. Now, half is paid by you and comes out of your pay and half is contributed by your employer. But don't be naive enough to think that the employers aren't factoring in the total cost of having you and that affects what your gross wages are. Trust me on this employers have to factor in your total cost. I've done this for many years on hiring people. Their employers are looking at all the costs associated with having you on staff and if you can Generate more money than what it costs. So if you did not have the FICA taxes, you could get paid more in gross salary. 12:59 So I'm using the full 15.3% for payroll taxes. That's some taxes you're paying. Now for state income taxes, I'm just gonna use 5%. Some states are more, some states are slightly less, but we're gonna use 5% here. And for federal income taxes for the average household income, we're gonna assume 12%, which is pretty darn close in terms of what it would be assuming basic deductions that somebody at this income level would have. 13:32 Now the average Household owns their home. You know we have over close around 60% or whatever. I mean it varies slightly each year. You know we were up to about two-thirds of People in the US own their own home. So we it's safe to assume the average person, average household in this scenario owns their own home and Using what average property taxes are and we come to about 3% of your gross income, average property taxes of just under 2,500 bucks. And then if you spent 30%, like this budget template Recommends, towards once, most of those ones are gonna have sales tax. So using average sales tax rates based off of different states would come to about 2% of your gross income. If you use 30% on once is gonna be in sales tax. So you add up your payroll taxes, your state income taxes, your federal income taxes, your property taxes in your sales tax. Those total 37% of your gross income for the average US household is going to the government, so almost 40% of your pay is going to the government. 14:49 Now if you look at what you're paying yourself in this budgeting template, it's saying 20% after tax. Save savings in this budget rule is going towards Investing and saving, so that's what you're paying yourself. So in this scenario, if you Make it apples to apples and I want to say, okay, 37% of my pay, my gross pay, is going to the government and I'm factoring this 20% that is after tax. So we got to make it apples to apples, so that's 13%. That 20% becomes 13% on your gross. So you are literally paying the government. 37% of your pay is going towards the government in this budgeting scenario for the average household in Only 13%. So you're paying the government over three times what you're paying yourself. That should make you sick to your stomach. 15:50 Now you could say well, really I'm paying the government 37%, so that leaves me 63%. I would definitely argue that Really, the only thing you're paying yourself is what you are saving and investing, because that is what is going to generate the passive income you need to be able to reach financial independence or to be able to retire. So when I say pay yourself. I'm looking at, what are you saving, investing that's going to generate passive income, and In this scenario, with using this budget Rule, you are only saving and paying yourself 13% of your gross income for the average US household, while you're paying the government 37%. Your goal should be to pay yourself more now, to based off where you're at. It may take you a little longer to get there, but your goal should be I'm paying myself more than I'm paying anybody else. When you have the goal to pay yourself more than you pay anybody else, whether or that be your debtors, your Government, you will be okay. You're that is what the ultimate goal is to get yourself to where you can pay yourself more than you're paying Anybody else, because it's your money that you're working hard for and you deserve it. 17:13 So let's summarize this myth. So the 5030 20 budgeting rule allocates 50% of your after-tax income to your needs and 30% to your wants, and 20% to saving, investing and debt payoff. If you don't have a budget, this can be a good starting point and it's better than doing nothing, and it gets you to start to think about your wants versus your needs. However, you're not going to reach your full Potential financially by taking a very broad and vague financial plan that isn't specific to your current situation and adjust with your life changes In one that doesn't take in consideration your financial goals. So let's just look at the seven reasons why I didn't like this again. The first reason was you can't have something vague and you need to be very specific about what your needs versus wants are. Think back to. You know you need a home. You need somewhere a roof over your head, but you don't need your dream home. That's a want. Your dream home's a want. Housing is a need. 18:25 The second point and thing you need to think of when you're budgeting is if you have debt, you need to go all in on getting out. Now I'm not talking about, like your mortgage with your home. If you have one of those, but any other consumer debt. You need to be all in. You can't just dip your toes in. You got to go all in and really attack it to get to where you're starting to be able to pay yourself more and you're not paying everybody else all your income that you're working for. So you got to go all in and that may mean you're contributing 40, 50, 60, 70% of your income to get out of debt as fast as possible. 19:02 The third point is you have to look at where you're at in your life stage. So if you're younger, you're attacking, saving and investing and getting out of debt. If you're older, you've done the work. You don't need to do that again. So that's the third point. Your budget needs to reflect where you're at in your life. And the fourth point was your budget needs to reflect your income level. If you're struggling income wise, you need to cut as many wants and I would even say there are no wants in your budget until you get your income level higher. And if you have a really high income, your needs are going to be very low as a percentage of your income and your saving and investing is going to be higher and you're going to reach that point to where you're paying yourself more than you're paying the government. The fifth point that you need to look at with your budget is when you started saving and investing and when you want to retire. Your budget should reflect that. And the sixth point is your budget has to reflect your financial goals. It is the tool you use to reach your financial goals, so it needs to reflect that and keep you on track for them. And the seventh point your ultimate goal is to pay yourself more than you're paying the government or anybody else. So if you're paying 30, 40% of your income to the government, I want to reach a point and you're going to have to get your income up to do this but I want to reach a point that I'm paying myself more than anybody else because, guess what, I'm the one working for the money I should be paying myself more. So those are the seven things your budget has to reflect when you're doing it. 20:46 Now for this week's action steps related to this myth. The first action step I want you to do is take your current budget and just compare it to this 50, 30, 20 budgeting rule. How does your current budget compare? Are you over or under in any one of the three categories? Just use it as a good baseline comparison. That's your first action step. 21:10 The second action step is to look at your current budget and does it reflect your financial goals? Where do you need to make adjustments to your budget to have it keep you on track towards your financial goals? So if you don't have goals, you've got to create your goals. But then look at your budget and it should reflect that. Where do you need to cut back? Where do you need to add? Remember, depending on where you're at, your budget doesn't have to be restrictive. Your budget is simply the vehicle to keep you on track to reaching your financial goals and reaching financial independence. So look at your budget and really comb through it as far as where can I cut? Where do I need to cut? And make small adjustments over time. So maybe adjust a category 3% or 1% or 5% this month and then adjust it another 1% next month, and you can slowly start changing your habits and get in your budget to where you ultimately want it to be. Don't make drastic changes out of the gate. Make small improvements each month and that will get you there. 22:20 Thanks for listening. Want to achieve financial independence? Go to ruggedfinancialcom where you can download my free PDF of the 12 Things to Do to Win With Money, and you can also sign up for my weekly money tips emails, where I cover the same tips and tricks and advice I walk all my clients through so you can begin your journey to financial independence. Thank you for watching and listening to this episode of the Money Myths Podcast. Please do me a favor and, if you found this episode interesting. Subscribe to the podcast so you can make sure you get all the future episodes. Also, leave a rating and review so you can help us grow this podcast, so we can lead more people to financial independence. And, lastly, please take a screenshot of the episode, share it on your social media channels and tag us using at ruggedfinancial. We will see you later.