The 50/30/20 Rule is a simple thumb rule to manage personal finances. According to this rule, you should divide your income (Income after tax) into three categories. 50% of your after-tax income on needs, 30% on wants, and 20% on savings and investment.
Needs are those things that are important for your survival and daily life. Examples of needs may be food, water, electricity, etc. Wants are something you desire extra like watching movies, buying luxury gadgets, etc.
The 50/30/20 rule is very helpful to manage personal finance and maintain a good balance in your budget. If you apply this rule in your life, you will notice that you are doing better than before. However, it is totally up to you whether you apply it or not.
U. S. Senator Elizabeth Warren popularized this budgeting rule through her book. The book’s name was All Your Worth – The Ultimate Lifetime Money Plan. Elizabeth Warren has written many books.
Why is it Important to Follow the 50/30/20 Rule?
Everyone wants to become financially independent and want to keep a good balance while budgeting. But when it comes to managing finance in the right way, almost everyone struggles, and some people make a random budget.
Even there are set people who don’t make any kind of budget. The world is full of distractions and it can get very easy to spend money on unnecessary items.
One notification from a food app or one sale going on in an online clothing store can become a challenge for your pocket. This is why it is advisable to have a budget and stick to it throughout the month.
The 50/30/20 rule is one of the best thumb rules when it comes to discussing personal finance. However, one should always remember that priorities keep changing with time and you must apply what is best for you.
There might be situations in your life where this proportion will not work out. In certain cases, you might have to adjust your expenses and spend more on your needs than your wants.
Or if all your basic needs are taken care of you can put your whole income into savings accounts. Your financial goals can vary from time to time depending upon the circumstances and your goals in life. Otherwise, the 50/30/20 rule works out really well on regular income days and it can help people a lot.
Now, let’s talk about the first portion of the 50/30/20 rule. Needs are those necessities that we cannot ignore in our life. These are the things that are crucial for our survival. After all, we work hard so that we can fulfill our needs.
Things that we do for leisure such as watching movies, and going out for dinner every weekend does not come under the category of needs.
The 50/30/20 rule states that 50% of your after-tax income should be reserved for your needs. If your expenditure goes beyond 50% you might have to decrease other desires such as wearing mediocre clothes and using a mobile phone of a local brand.
Here is the list of some items which can come under the category of needs:
- Utility bills like electricity bills, water bills, etc.
- Mortgage loans/personal loans Emis
- Rent – If you are living in a rented house then the rent may come in the category of needs
- Groceries – These are very important for survival. Nobody can survive without eating food.
- Basic Clothes
- Other individual needs such as – medicines, healthcare, life insurance, health insurance, etc.
Your wants consist of those things that you do for the purpose of self-satisfaction and pleasure. Basically, your wants are those items without which you can survive but without needs, possibly you can’t.
It is totally your personal choice whether you are buying an ordinary bag or a luxury bag. Desire is unlimited and you can buy anything with your money. If you buy an ordinary watch and a luxury watch, what do you think the time in both watches will be the same or different? I know your answer.
As per the 50/30/20 rule, you should keep your expenditure on wants up to a maximum of 30%. If you do more than 30% of your income, then you have two options. Whether you reduce your needs budget or reduce your saving and investment.
Now, let’s have a look at some items which you may consider as wants.
- Going out for leisure such as – movies, shopping, and dining.
- Buying unique and or luxury electronic gadgets like watches, and music items.
- Luxury bags, shoes, branded clothes, etc.
- Going for a national and or international trip.
- Spending on hobbies – dance classes, Zumba membership, dance, etc.
Wants make our lives more interesting and fun due to which 30% of our income should be spent on our wants. The list of wants may be so long. There is no limit to your desire and You have unlimited choices but you should do it within your budget.
Tip – Wondering how to decide if something your want or not? Whenever you think of buying something, do you instantly go and buy or think about it for a while? This confusion exists for most of us. There is a very simple solution to it.
First, stop scrolling online platforms frequently. Because if you scroll it more, there are more chances that you get attracted towards many items. Second, if you want to buy something, work out it properly and then do the purchase. It should not be like you have purchased the item and later you are regretting it.
The 50/30/20 rule is helpful when you apply it with full discipline and maintain consistency. If you apply for it for 15 days or 30 days only, you might not get long-term benefits. You should make ideal budgeting and should follow it well. And You should also identify your problem areas and should work out how you can do better.
When you are done with your needs and wants, it is time to save and invest some money. At least, 20% of your income should go into savings and investment. First and foremost you need to save some money as emergency funds in your savings bank account. You should keep your emergency fund separate. Even you can open a separate account for it to maintain it well.
It is wise to have at least three to six months of emergency funds in your account. You should be prepared for any sudden circumstances. When you are done with saving enough for emergency funds you can move towards other options for savings.
For instance, opening a mutual funds account, investing in stocks, and opening a fixed deposit. There are a lot of options are available for savings and investment. However, you must understand the instrument well and should know the risk level.
Here is a list of some instruments for savings and investment.
- Emergency funds – saving
- Fixed deposits
- Mutual Funds
- Savings account
- Government saving schemes.
How to Execute the 50/30/20 Rule?
The application of this rule is very simple and there is nothing technical about it. Simply, Note down your monthly income after tax in a diary or notepad or on your computer. To understand better let’s take an assumption that your monthly income after tax is 40,000 Rupees.
Apply the 50/30/20 rule.
Total after-tax income = 40,000 Rupees
50% needs – 40,000/100 X 50 = 20,000 Rupees.
30% wants – 40,000/100X 30 = 10,000 Rupees
20% savings – 40,000/100X 20 = 5,000 Rupees
As explained above, this is an ideal budget rule. However, it is important to plan your budget according to your circumstances when required.
Advantages of the 50/30/20 Rule in Personal Finance.
1- The 50/30/20 rule makes money management a very simple task. The 50/30/20 rule requires only a minimal amount of prior math to keep track of your finances.
2- While some other budgets need you to keep track of a number of different categories of expenses, this one only demands that you take three into account.
3- You can save and invest 20% of your monthly income according to the 50-20-30 rule, which will be beneficial in the long run.
4- The 50-20-30 budget is a flexible personal budgeting choice because it may help people organize their finances regardless of these specific features.
5- It can assist people in sticking to their budgets and achieving their long-term financial goals because it is an easy budgeting strategy to follow.
If you have decided to follow the 50/30/20 rule you should definitely use a spreadsheet to keep a track of your performance. You can create a spreadsheet through Microsoft Excel or Google sheets.
Conclusively, the 50/30/20 rule states that you should divide your income after tax into three parts, 50% on needs, 30% on wants, and 20% on savings and investment. You must not ignore saving and investment because this money is very important for your future.
You don’t know your future and there may be any kind of sudden emergencies as well. You will also need money for your other future goals also. So apart from needs, and wants, this rule states that you should use 20% of your income on savings and investments.
Maybe the rule of 50/30/20 is not ideal for everyone and maybe there is some better proportion as well. And of course, if you apply this rule also, you can set your own proportion and implement it.