How much you contribute towards your goals (your saving rate) is a key determinant of financial success, more so than your investment returns. However, disciplined saving is hard to implement, particularly with many competing needs and wants, and a busy life. One tool to help you get started is the 50/20/30 rule. 

The rule states that you should devote 50% of your after tax income to your necessities, 20% to saving for your financial goals, and 30% to your wants. The rule is a powerful starting point if you are trying to take control of your financial life. It starts with computing reasonable spending and saving targets, a good starting point to help you align your savings and spending habits with your goals. Notice there is a reason we write it 50/20/30 rule, and not 50/30/20: saving for your goals has priority over your wants! Let’s break the rule down.

The 50% to Needs

Your needs category includes all the essential expenses, like food and shelter. They include rent or mortgage payments, utilities like electric power, water, and gas, telephone bills, groceries, and basic clothing needs (including work clothes). Basic spending on transportation needs is also included in your needs. Minimum car or other loan payments are included as part of your needs. However, keep in mind that some of these costs may be above strict needs. For example, minimum payments on a luxury car are at least partially a want.

The 20% to Saving for Goals

The first saving goal should be to fund or replenish a safety net. Next is your retirement goal. Most people should start saving about 10% of their income for retirement. Higher earners should make this a starting point, and increase it over time to about 20%. You may also have other goals, including family goals (e.g. college) and lifestyle goals. Because you can fund some lifestyle goals by borrowing, debt repayment above your minimum monthly payments is considered part of this saving bucket. Take a look at our goal setting process.

The 30% to Wants

Notice the 50% needs does not include spending on extras, like subscriptions to streaming services, cable or even wifi. That is part of entertainment, which is a want. Clothing beyond your basic needs and what’s required for work is not a need. There is nothing wrong with wanting to spend more on clothing if that’s important to you. This additional spending is part of your wants. Your wants include spending on entertainment, like eating out, movies, etc., and shopping on things you like, including electronics, hobbies, vacations, etc. It also includes spending more than strictly needed for a good or service. For example, a first class upgrade when a coach seat might do, a new phone every two years, or a luxury car instead of a basic model. This type of spending is called discretionary spending, because you have some discretion over it and you can adjust it.

How to Get to Your Targets 

Start with your paystub, take your gross income, and subtract your tax withholdings. ADP has a calculator that does it for you. If you are not sure if your withholdings are right, and make a determination using the IRS calculator.  Suppose you are married and make a combined $140,000 per year, and your taxes amount to $25,000 including federal taxes, Social Security and Medicare contributions.  Your after tax income is $115,000 annually, or roughly $9,600 a month.

Calculate your percentages

The 50/20/30 rule is useful because it lets you set reasonable targets that can help you get started with your goals. Most budgeting tools help you categorize your expenses, but don’t help you understand or set useful targets. 

Using the example above, from the we have:

• 50% to Needs: $4,800 a month.
• 20% to Saving for Your Goals: $1,920 a month.
• 30% to Wants: $2,880 a month.

Once targets are set, you can use your actual expenses to see how you can adjust spending to align with your targets, particularly your savings goal. In this example, we should have a total savings capacity of almost $3K a month.

Allocate Your Actual Spending

With your percentages set, it is now time to compare them with your actual spending. It should be relatively easy to come up with your monthly spending on Needs and Savings. Use at least three months of data and average the expenses out, to eliminate some month-to-month variation. Wants may be a bit more erratic, so you may need to use at least 6 months or preferably a year, and then calculate a monthly average. Once you get a handle on your spending, you can also use the momentum to create a budget.

Grain of salt

The goal of the 50/20/30 method is to help you take control of your finances, and help you focus on saving for your goals. Since it’s a very simple process, you should think of these percentages as your starting point. It may work well for someone in the early stages of a working career in areas with average housing costs. However, it may require adjustments. 

• In high cost of living areas, the Needs bucket may be higher than 50%. If you are renting and are much above the 50%, consider options to reduce your monthly rent. Consider moving into a smaller place or a less expensive neighborhood might work for you.  If you are making mortgage payments, you can consider part of the equity you are building on your house as part of your savings. This can help you adjust the percentages to Needs and Savings, somewhat, particularly, if you plan to retire in a less expensive area.
• If you are a high earner, the spending percentages on Needs and Wants should come down, and the Goals should go up. For example, while a 10% saving rate applied to retirement is a good starting point, high earners should consider saving 20% just on retirement. As your income grows, your Goals bucket should be greater than 20%. You may want to consider a full financial plan.
• Having set a savings target, and having checked its feasibility based on actual spending, the next step is to automate your savings. You do that with your 401(k) plan, do it with your other savings or investment accounts as well.
• After some work on your budget, what if you still find the targets to be unfeasible. Save as much as you can, and consider the allocations to Needs, Savings, and Wants as targets to work towards. Commit to saving more as you earn more or experience life changes.

Until Next Time!

Massi De Santis is an Austin, TX fee-only financial planner and founder of DESMO Wealth Advisors, LLC.  DESMO Wealth Advisors, LLC provides objective financial planning and investment management to help clients organize, grow, and protect their resources throughout their lives.  As a fee-only, fiduciary, and independent financial advisor, Massi De Santis is never paid a commission of any kind, and has a legal obligation to provide unbiased and trustworthy financial advice.

When I finally got out of school and started getting a decent paycheck, my first thoughts were mainly about all the things I could spend the extra money on. That nicer car, a new bike, better hotel and restaurant choices, and more. If you feel this applies to you, know that it’s perfectly natural and very common. In personal finance, the steady increase in spending as your income grows is called lifestyle creep. Some lifestyle creep is good and understandable. After all, part of why we are working hard is to get the things we like. There is the risk, however, that you get used to spending habits that hamper your ability to reach more meaningful long-term goals. 

How it happens

Lifestyle creep typically starts when you get a raise or see your checking account growing to higher levels than you are used to. If you have money to spare, the easiest thing to do with them is to spend them. You reward yourself for the hard work you have been doing. A nicer car, better clothing, a first-class upgrade, you go out to restaurants more often, and so on.

The problem isn’t that we do all this. The real problem is that left unchecked, lifestyle creep can create bad habits. You get used to the lifestyle and what you initially thought was a reward now becomes a necessity. Slowly, you find yourself making twice as much money but still haven’t started saving for important things like retirement or your kids’ education. 

A matter of mindset

The biggest issue with lifestyle creep is one of mindset. You start viewing discretionary and luxury expenses as necessities or something you deserve and overlook the opportunities that saving more could provide you. As a result, you may end up prioritizing spending relative to achieving long-term goals. If you are a high earner (find out here) and you often feel like you don’t know where your money is going, then lifestyle creep may be a problem.

Make a plan

The best tool to limit or eliminate the negative effects of lifestyle creep is a financial plan based on your values and priorities, even a simple one. The main benefit of a financial plan is to change your mindset, from just “going through” life to “having a strategy” to make the most out of your resources, including money. Lifestyle creep is a result of not having a strategy. Going through the process of identifying your values and setting measurable goals and actionable items can change your mindset. Kowing what’s really important to you can help you focus on it and lead to better decisions today. So our first advice is to think about why money is important to you and start planning.

Be aware of your spending habits

Lifestyle creep can start small and doesn’t have to be about luxury goods. It generally includes what we call discretionary spending. Discretionary spending isn’t just about things that you don’t need. It also includes spending on something more than what is strictly necessary, like buying a pro bike when you are only cycling once or twice a week (ouch!). The key to deciding whether some spending is good or bad, however, depends on your values and priorities. If fine wine is your passion, spending on wine is not a bad thing. To find out how well it aligns with your values, track your spending for a while. Try this challenge: write down all your expenses for 30 days. At the end of the period, compare your spending to your values and priorities. Is your spending in line with the things that matter in your life? After tracking your spending for a while, give budgeting a try.

Some other tips to control your spending

If you have worked on your simple plan and started tracking your spending, try some of these ideas to help you reduce the risk of lifestyle creep.

1. Pay yourself first. Saving is not a burden if you realize you are buying a slice of your most important goals. Automate some savings each month. You can reward yourself for this good behavior by also setting aside some ‘fun’ money.
2. Use goals-based investing. Writing down goals and setting savings aside for each goal helps you remind you what’s really important to you and gives you meaningful feedback. For example, if you are on target for your goals and find yourself with extra cash, you don’t feel bad about spending more.
3. Make gradual changes. As you track your spending commit to small, realistic spending reductions and commit that money to savings. Getting started is big progress.
4. Spend intentionally. Avoid spending for the wrong reasons, like things or features you don’t need just because you can afford them, but don’t feel bad about buying something expensive if you actually value it. Make a list of your monthly wants and don’t buy anything right away. Let it sit and go back to it after a couple of days to prioritize them.
5. Beware of debt.  Debt is a commitment. Just because you have good credit and can afford to make the payments, it does not mean you should get the loan. When you take out debt, you are committing yourself to make payments for the duration of the loan. Every additional dollar of debt you have to pay back is a dollar you could use on something else.

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Everyone deserves to indulge every now and then, so you shouldn’t feel bad if you don’t think you could live the same way you did during college or grad school. The key is to be aware of your spending habits, making sure they align with your values, and to understand the opportunities that saving today can buy you tomorrow.

Until Next Time!

Massi De Santis is an Austin, TX fee-only financial planner.  DESMO Wealth Advisors, LLC provides objective financial planning and investment management to help clients organize, grow and protect their resources throughout their lives.  As a fee-only, fiduciary, and independent financial advisor, Massi De Santis is never paid a commission of any kind, and has a legal obligation to provide unbiased and trustworthy financial advice.