If you are someone who is bothered by the question ‘where did it all go?’ Every month, and struggling to keep up with your expenses, the 50/30/20 rule of budgeting will surely be your savior.
This rule sets a road map for how to plan your expenditure. How you distribute your after-tax income among various needs will determine your budgeting skills. The rule will instill financial discipline in your life.
How does it function?
The 50/30/20 rule is easy to understand and implement. As per the rule, you have to identify your needs, wants, and savings, then allocate 50% of your income to needs, 30% to wants, and 20% to savings.
That’s pretty much it. This will ensure you plan for your short and long-term goals and don’t have to compromise on quality of life.
The rule to work on your after tax income to justify your needs, wants, and spending was popularized by Senator Elizabeth Warren in her 2005 famous book “All your worth, an ultimate lifetime plan”.
Defining needs, wants, and savings
Needs: Needs are those expenditures that we can’t avoid and are part of our everyday life. Expenses like paying bills, buying groceries, rent, school fees, policy premiums and others. We basically can’t operate without paying for our needs.
The rule is aware of this fact and wants you to allocate 50% of your after-tax income to pay for your needs.
Wants: Can be defined as what we desire to have. It is not what you require for survival, but what you aspire to. Wants include movies, dinners, shopping, paying for your hobbies, etc.
Yes, it is ok to pamper your wants, but how much and how frequently is the question.
The rule knows that it is impossible to live life without addressing our wants. Very smartly, it allows us to allocate 30% of our after-tax income to our wants.
Savings: The third pillar of the rule is saving, and it is one of the most important things that take care of our future. The savings bucket is non-negotiable, and you should honestly put 20% of your monthly income in the bucket. Utilizing your savings wisely will ensure a strong financial foundation. You could open a zero balance savings account, invest in a retirement fund, or build your emergency corpus.
The 50/30/20 rule of budgeting is a tried and tested formula to help you manage your finances and also build for the future. Learn more about this and other budgeting tips to help manage your finance better.