Rule of Thumb: The 50/30/20 Budget Rule

Rule of Thumb: The 50/30/20 Budget Rule

In this issue:

• Latest in Retirement Savings & Personal Finance
• Rule of Thumb: The 50/30/20 Budget Rule
• Simple Budget Calculator
• Market Overview

Latest in Retirement Savings & Personal Finance

Here is some of the latest news:

Retirement Savings: IRS Limits for 2025

Entering the new year, the IRS contribution limits have been raised for various retirement savings plans for 2025:

• 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan (TSP):
  • Annual Limit: $23,500
    • Catch-up Contribution (Age 50+): $7,500
    • Super Catch-up Contribution (Ages 60-63): $11,250
• Solo 401(k):
  • Annual Elective Deferral Limit: $23,500
    • Catch-up Contribution (Age 50+): $7,500
  • Total Contributions (Employee and Employer):  At most of $70,000 (from $66,000 in 2024) or 100% of compensation (minus self-employment tax), whichever is less.
• IRA (Traditional and Roth):
  • Annual Contribution Limit: $7,000
    • Catch-up Contribution (Age 50+): $1,000
• SEP IRA:
  • Annual Contribution Limit: Lesser of $70,000 or 25% of compensation, excluding catch-up contributions.
• SIMPLE IRA:
  • Annual Contribution Limit: $16,500
    • Catch-up Contribution (Age 50+): $3,500
  • Under SECURE 2.0, some plans might offer a higher contribution limit of $17,600 for certain employees.

Generational Perspectives on Financial Success

The bar has been raised: Gen Z (born 1996–2012) individuals believe they need approximately $9.5 million to feel financially successful. This contrasts with the far more moderate $5.6 million goal of the previous generation, Millennials (born 1981–1995), and Gen X (born 1965–1980), who aim for around $5 million.

Retirement Savings Projections for Gen Beta (Newborns)

Meanwhile, experts predict that children born in 2025, known as Generation Beta, may need an average of $1.88 million to fund their retirement, with some estimates climbing as high as $5 million. Not to be confused with the amounts mentioned above, this figure reflects basic retirement needs, not the level required for a financially successful retirement. Early financial planning and education are key to preparing for these future demands. Save more & invest early!

Rule of Thumb: The 50/30/20 Budget Rule

We like rules of thumb because they provide all of us—yes, even experts, believe or not—with an intuitive and quick way to have a guide to follow. You can, and likely will, tweak these rules to better fit your own situation. From our experience as scientists and engineers, don’t fancy those convoluted or so-called ‘sophisticated’ rules. Most of the time, simple rules not only work but often work just as well, if not better. The more complicated something is, the easier it becomes to stray from it and make significant mistakes. As Buffett wisely said about investing, there’s no need to swing for the fences to hit a home run.

The 50/30/20 rule is just one of these popular rules of thumb. It’s a budgeting method that helps individuals allocate their after-tax income across three main categories: needs, wants, and savings. Here’s a detailed breakdown of this budgeting strategy:

1. 50% for Needs (Essentials)
   • This category includes necessary expenses that you can’t avoid
   • Examples include:
     • Housing (rent or mortgage)
     • Groceries
     • Basic utilities
     • Transportation
     • Insurance
     • Minimum loan and credit card payments
     • Child care or other work-related necessities
2. 30% for Wants (Non-essentials)
   • This portion is allocated for discretionary spending on things you enjoy but don’t necessarily need
   • Examples include:
     • Entertainment
     • Dining out
     • Hobbies
     • Vacations
     • Gym memberships
     • Streaming services
     • Cable TV
3. 20% for Savings and Debt Repayment
   • This category is dedicated to building financial security and paying off debt beyond minimum payments
   • It includes:
     • Emergency fund contributions
     • Retirement savings (e.g., 401(k) or IRA contributions)
     • Investments
     • Debt repayment above minimum requirements
   • A rule of thumb for this is: always tackle debts with high interest rates first! However, for other debts and savings, you will need to perform some basic calculations. See Smart Rules of Thumb to Manage Your Personal Debts.

Implementation and Flexibility

As said before, the rule is meant to be a guideline and can be adjusted based on individual circumstances:

• Calculate your after-tax income and apply the percentages to determine your budget for each category
• If your essential expenses exceed 50%, you may need to adjust the other categories or consider the 60/30/10 budget variation

Benefits of the 50/30/20 Rule

• Simplicity: Easy to understand and implement
• Balance: Helps create a balance between current needs, enjoyment, and future financial security
• Flexibility: Can be adapted to different income levels and life situations

Other factors to consider: 

• Location and cost of living can significantly impact the feasibility of this rule
• Some expenses may not clearly fit into a single category and require personal judgment
• The rule may need adjustment for those with specific financial goals or circumstances

Remember, while the 50/30/20 rule provides a first-level guideline, merely adopting such a rule to begin with will go a long way compared to many who have no actual rules to follow!

Tools & Tips: Simple Budget Calculator

Following up on the above discussion, we present a simple budget calculator that helps you plan your spending and savings with ease. By entering your monthly income, desired budget allocations, and itemized expenses in detailed subcategories for Needs, Wants, and Savings, you’ll gain a clear understanding of your financial priorities. The calculator dynamically updates totals and highlights deviations, ensuring your budget stays aligned with your goals.

You first enter your income along with the desired budget allocations in the three major categories. By default, the allocations are set to be 50/30/20 as follows:

You can then enter the actual amounts you have spent or plan to spend in each subcategory within these three categories, such as:

The calculator dynamically calculates and give summary outputs like the following:

This is a simple and quick calculator designed to help you monitor your budget. Many excellent budget calculators offer more features and automation, which we’ll discuss at another time.

Market Overview

Stocks and bonds recovered last week, driven primarily by positive economic data, such as the U.S. Consumer Price Index (CPI) for December showing a lower-than-expected increase. The annual core CPI rate reached its lowest level in four years, fueling hopes for a higher likelihood of a Federal Reserve rate cut.

Additionally, investors have expressed high hopes for the incoming administration’s business- and market-friendly policies. Now that the new administration has begun its work, it remains to be seen how the plans outlined during the campaign will be implemented and what positive or negative impacts they may have on the economy and financial markets in the near, intermediate, and long term. For now, investors appear to have their “animal spirits” ignited.

The following table shows the major asset price returns, as of last Friday: 

Struggling to Select Investments for Your 401(k), IRA, or Brokerage Accounts?