Why Warren’s 50-30-20 Rule is Terrible Advice

So Elizabeth Warren's good rule of thumb, as she calls the 50 3020 rule, may not be so good. We think this budgeting tool is a mistake. Let's suppose that your after-tax income is $40,000 a year. 50% of that in most places around the United States won't cover your basic needs. What if you're making $200,000 a year? What sense does it make to spend 80%, or 160,000 a year, on needs and wants? The higher your income, the more you're going to need to save for a successful retirement.

The rule is 20% goes towards debt repayment, but here's the problem: if you have high-interest debt, prioritizing lifestyle over debt repayment, that can cost you big time in the long run. [Music]

One of my favorite quotes by Albert Einstein is, "Every problem should be simplified as far as possible and no further." The 50320 rule fails this axiom.

Welcome to another edition of We're Talking Money. I'm Phil Clark, and today we're going to dive into something called the 503020 rule. US Senator Elizabeth Warren popularized this technique in her book All Your Worth: The Ultimate Money Plan. This rule calls for 50% of your money being spent for need and 30% being spent for your wants. The remaining 20% would be spent on debt and, say, retirement savings. Now, it all sounds good, and this is of course after tax.

Many people like this plan because it's simple, it's easy and almost thoughtless. But my goal is to illuminate the many blind spots that exist in the 50 30 20 rule, and I'm going to share with you why it's one of my least favorites.

Let's look at how the 50320 rule works. First, 50% of your after-tax income is allocated to need. And so these would be the kind of things that if you had to do without them, it could create some pretty severe consequences. Think about your mortgage or your rent payments, phone bills, electric bills, you, utilities, internet service, and then health care premiums. There's plenty of others, but those give you an idea of what need is all about.

Next, it's allocating 30% of your after-tax income to your wants. These types of expenses are generally not the kind of things that are going to increase your net worth: cable TV, think about a gym membership, going out to eat, think about upgrading to the latest mobile phone even though you have one that works perfectly fine.

Finally, the last 20%, that's allocated to savings. Things like building an emergency reserve fund that might equal at least 3 months of your needs. Saving in a 401k plan; if your employer offers a match, you want to save at least enough so that you get the full match. Funding an HSA account. And you might consider paying down any high-interest credit card debt, and you want to pay that off as fast as you can. And lastly, you could invest in a taxable account for any goals that are going to come before retirement.

All of this sounds really good, right? Let me show you a visual so that you can better understand why we think this budgeting tool is a mistake. Now, from this graphic you can see for lower household incomes, 50% of your income, it may not be enough to cover basic needs. The more you earn, the savings component may have you coming up short at retirement.

This 503020 rule, it absolutely does not create a one-size-fits-all. It's anything but a solution. It just doesn't take into consideration an individual circumstances. Everyone's financial situation is different. Debt, housing cost, income, this helps make up your financial footprint, and just like a pair of shoes, one size doesn't fit everyone.

The consumer can sometimes often get confused about needs and wants, or here at OmniStar we call that required versus desired expenses. Let's say that you buy an expensive piece of art to decorate your home. Now, that's clearly a desired purchase. On the other hand, something like paying excessive rent, this one's a little harder, because you could justify that your rent, even though it's excessive, might seem like it's a required expense. But could you rent a room to a roommate? Could you move to another neighborhood where your rent might be significantly lower? So that kind of decision has to be considered. You have to recognize when it's truly required IR ired, or is it desired.

So Elizabeth Warren's good rule of thumb, as she calls the 503020 rule, may not be so good. In fact, we think it fails in many more ways. Let's suppose that your after-tax income is $40,000 a year. 50% of that probably in most places around the United States won't cover your basic needs. On the other hand, what if you're making2 $1,000 a year? What sense does it make to spend 80%, or $160,000 a year, on needs and wants? Doesn't leave a lot for saving.

And keep in mind, the higher your income, the more you're going to need to save for a successful retirement, or you'll be risking a major lifestyle change when your income stops. Moreover, you won't have enough saved should an unforeseen circumstance occur, even well before retirement.

Now we come to the weakness of failing to consider debt repayment. If you have high-interest debt, prioritizing lifestyle over debt repayment, that can cost you big time in the long run. The rule is 20% goes towards debt repayment, but here's the problem: that rule doesn't consider how much it might take to properly fund your emergency reserve account, pay for kids' college and adequately save for your retirement.

Instead of blindly following this archaic rule that seems to be as hearty as a cockroach, I encourage you to get a plan that's designed for your needs and priorities. In fact, I would encourage you to work with a good wealth management team or financial advisor who has the skills and knowledge to help you build a plan specifically for you.

So I hope this edition of We're Talking Money has inspired you to toss the 503020 rule in the trash can, right where it belongs. Your financial house is your own, so don't try to use a boilerplate plan designed for the masses. It wasn't designed for you. Don't use it.

Thanks for watching. If you found this information helpful, please subscribe to our channel, give us a thumbs up and ring that bell so you never miss an episode with great advice and suggestions to help you achieve your financial goals. I'll see you next time on We're Talking Money.