What is the 50/30/20 Rule of Budgeting?
The 50/30/20 rule of budgeting is a simple method that helps you manage your money more effectively. This basic thumb rule is to divide your post-tax income into three spending categories – 50% for needs, 30% for wants, and 20% for savings. This is not a hard and fast rule but a simple guideline that helps you build a financially strong budget.
Use Income Tax Calculator to calculate your post-tax income.
This rule helps to keep your expenses balanced across the main spending areas and put your money to work more efficiently. Also, with only three major categories, you can save yourself from the time and stress of understanding the details every time you spend. In other words, it helps to build a structured spending habit. Also, it helps to reach your financial goals by saving more.
Senator Elizabeth Warren in the US wrote a book in 2005 titled “All Your Worth: The Ultimate Lifetime Money Plan”. This book concludes that you don’t need a complicated budget to get your finances in check. Instead, using this rule, you can balance your money across needs, wants, and savings.
Let’s look in detail at what the 50/30/20 rule of budgeting rule looks like –
50% for Needs
Needs are the basic expenses that you absolutely require for your living. The basic requirements of food, shelter and clothing fall in this category. Thus, your needs dominate the expenditure bucket, and you cannot live without them. Some of these expenses include the following –
- Utilities like electricity bills, water bills, etc.
- House or car EMIs
- Children education expenses
- Insurance expenses
As per this rule, half of your post-tax income is used for a basic standard of living with all the obligations to take care of. Thus, they are always on the urgent list of money. If you fail to make these payments, you are likely in trouble or gathering more obligations for next month which will include extra charges for late payments.
This section does not include TV cable, Netflix, eating out, lifestyle, or entertainment expenses. There is a possibility that you may spend more than 50% of your post-tax income on your needs. Even though this is undesirable, you can cut back on your luxuries. Basically, you need to look to increase your income or look for alternatives where you can downsize your current lifestyle.
30% for Wants
This is the second component of the budgeting rule. These are expenses that are unnecessary for survival but considered luxuries of life. In other words, you can do without these articles but would love to have them. It includes all expenses that make your life more enjoyable. Some of these expenses include the following –
- Entertainment expenses like movies, Netflix, etc.
- Dining out
- Gym membership
- Buying the latest gadget like iPhones, smart tv, etc.
This list is never-ending. You can always look to regulate these expenses. Most of the wants are expensive and require a lot of money. But there are cheaper alternatives too. For instance, buying traditional watches over luxury watches, buying a hatchback over buying an SUV.
Sometimes you are also tempted to buy expensive items and satisfy your wants. You may purchase these items on no-cost EMIs or schemes with zero processing charges. However, there is nothing free in this world. There are always some hidden charges which are not apparent to us.
Hence, if you feel you are spending more than 30% of your income towards wants, you can look to cut back these expenses. However, this rule does not ask you to stop enjoying life by giving up on items that give you joy. But it is a tool that allows you to watch your spending habits and be in control.
20% for Savings
This is the last and most crucial component of the budgeting rule, which facilitates financial planning. This money helps to take care of your future needs. It ensures that these savings help you enjoy the same lifestyle that you are currently living. This portion of funds can be used for
- Emergency Funds
- Investments in mutual funds, stocks, ETFs, gold, or any other instrument
- Tax saving funds like PPF, NPS, ELSS
- Loan Prepayment
- Planning for long-term goals like children’s education, marriage, retirement, etc.
You must always aim to increase your savings over time and make sure you accumulate funds toward your financial goals. Also, this portion of savings shall be appropriately planned. You can start with a certain amount of emergency funds for unfortunate events like medical or personal crises. After the emergency funds are ready, you can put your money in different investment plans. However, you must ensure that these investment schemes can provide inflation-beating returns over time and give access to your money anytime.
How to Apply the 50/30/20 Rule?
The following are the steps to apply the 50/30/20 rule of budgeting –
- Calculate Post-Tax Income: If you are a self-employed professional, your post-tax income will be what you earn in a month, minus your business expenses and the amount set aside for taxes. If you are an employee, look at your payslip and see how much money you receive in your bank account. If the payslip automatically deducts health insurance or pension funds, add them back.
- Track Previous Month Expenses: You need to account for all your expenses in the previous month and sort them across broad categories like rent, groceries, shopping, leisure, entertainment, etc. There are budget track apps available, or you can use excel.
Now split your expenses across three categories: needs, wants, and savings. A few things to keep in mind are need is an essential expense that you can’t live without. If the expenses are optional, then they are luxuries. And savings are debt prepayments, retirement contributions, investments or emergency funds. However, expenses such as EMI are a part of needs, while loan prepayment is considered savings.
- Evaluation: Finally, you must assess how much you spend across the three categories. For instance, if you spend less than 30% on luxuries, you can shift that additional amount toward savings. If your needs are below 50%, you can plan for your savings goals and a vacation. Therefore, you can adjust the budget to match the 50/30/20 rule.
Example of the 50/30/20 Rule of Thumb
The following is an example to understand the 50/30/20 Rule of Budgeting. If Mr. Akash earns INR 40,000 per month, his monthly expenses might look something like the below –
|Phone & Internet||600|
|Total Expenses (50% of INR 40,000)||20,000|
|Cable TV & streaming||1,500|
|Movies & Events||2,000|
|Total Expenses (30% of INR 40,000)||12,000|
|Total Savings (20% of INR 40,000)||8,000|
Frequently Asked Questions
Budgeting is a tool that helps you analyze how much money you earn or save over a particular period of time and how you plan to spend it. It simply means balancing your expenses with income. Also, it helps to create financial stability. Therefore, this forecasting process helps you plan for your future in a structured way.
There are several advantages of the 50/30/20 rule of budgeting. It helps you manage and organize your finances with basic maths by dividing them into three categories. Also, it can help anyone regardless of their individual factors. Furthermore, it helps you understand what you can afford and helps you plan for your future financial goals.
The 50/30/20 rule budget is suitable for everyone. Even when starting your career, you must save some portion of your post-tax income. It helps to build financial discipline and prudence with your income. The earlier you start, the better your life is. The power of compounding and regular savings can help you build your net worth and systematically plan your goals. Thus, this is the path to wealth creation in the long term.
Paying a debt like for a home or education is considered a financial goal. It means you should allocate 20% of savings of your budget towards paying the debt. However, using a credit card for your luxury spending will be considered under 30% wants of the rule of budgeting