50 30 20 Rule of Budgeting Explained

TL;DR

• The 50:30:20 rule says that you should divide your monthly income in a 50:30:20 ratio to plan your budget efficiently. 
• Not more than 50% of your post-tax income should go towards your needs. This includes food, housing, utilities, health, etc. These are things you cannot avoid spending money on.
• 30% of it should go towards your wants. Wants include dining out, shopping, vacations, entertainment, and many more. These are mostly the things that you have a choice not to spend money on, but you still end up doing so because you ‘want’ it.
• 20% of your income MUST be saved. Savings are what help you stay afloat till the end. No investment is too small, and with passing years, you can receive the benefit of compounding.
• To implement this rule in your life, first, calculate your post-tax income, then analyze your expenses and categorize them into needs and wants. Once this is done, you can allocate funds to each expense while implementing the 50:30:20 rule.

Introduction

“It’s not your salary that makes you rich; it’s your spending habits.” 

– Charles A. Jaffe

Personal finance is a word that is familiar to all of us. It refers to managing your finances in a way that is sufficient for your daily needs, helps you live a comfortable lifestyle, and promotes savings. However, as easy as it sounds, not everyone is efficient in planning their finances. As a result, you can very conveniently find numerous rules on budgeting, saving, or investing on the internet. One such rule for saving and investing money is the 50:30:20 rule.

The 50/30/20 rule helps you maneuver your monthly budget efficiently by allocating your income into three categories – Needs, Wants, and Savings. This article will explore more about this rule and help you plan your finances in an efficient manner. 

What Is the 50 30 20 Rule in Budgeting? 

The 50 30 20 rule was first popularized in a book called ‘All Your Worth: The Ultimate Lifetime Money Plan’ by the current US Senator Elizabeth Warren and her daughter, Amelia Warren Tyagi. This rule says that you should divide your monthly income in a 50:30:20 ratio to plan your budget efficiently. 

Following this rule will help you stay disciplined and keep track of your expenses. Once you have identified your expenses for each bucket of Needs, Wants, and Savings, you are likely to follow a more balanced approach and focus on where you spend money and how to minimize it. This helps you to filter the noise of unnecessary expenses and focus on the areas that are quintessential for your living.

Breaking Down the 50-30-20 Rule of Money

50% needs  

Needs are the essential things required for your survival. This includes food, housing, utilities, health, etc. But not everyone’s needs are the same. However, a few basic needs are the same for everyone. The best way to keep a hold on these spendings is to make a list and estimate the cost. 

You can gauge your spending graph by making such a list. Needs generally form a major portion of your spending. The 50 30 20 budgeting rule says that, from your after-tax income, you can spend 50% of it on needs. 

30% wants

Wants are like a double edge sword. If not used prudently, it can prove detrimental to your finances. Wants include: dining out, shopping, vacations, entertainment, and many more. These are mostly the things that you have a choice not to spend money on, but you still end up doing so because you ‘want’ it. 

According to the rule, you can spend 30% of your income on these wants. So, if your after-tax monthly income is Rs. 30,000, you can spend Rs. 9,000 on your wants. Although the lesser you spend, the more liberty you will have to save.

20% savings

This is the most crucial aspect of the 50 30 20 rule. Needs and Wants are your cash outflows, and savings are what help you stay afloat till the end. It helps you live a stress-free life like a golden retriever that just happens to have his meal. 

You should develop a habit of saving 20% of your income each month. Even if you think the amount you are saving is small, do not doubt it. No investment is too small and with passing years, you can receive the benefit of compounding on your investment. If you’re looking to get started, check out Mudrex Vault to earn up to 10% interest on your invesments.

How to Use the 50 30 20 Rule in Real Life?

Now that we know what the 50 30 20 rule is, let’s quickly jump to how it can be used in real life.

What is your income?

This is the first and foremost step. You need to calculate your after-tax income and plan your budget accordingly. If you are an employee, all details are palpable in the pay slip. If you are a business owner or a freelancer, your after-tax income is what you have earned minus your business expenses.

Analyze your spending patterns

You should analyze your spending pattern for the past few months to know how you can create a budget. You can do so by using apps that track your expenses and categorize them. After getting a picture of your expenses, simply bifurcate them into three categories: needs, wants, and savings.

Make a budget based on your spendings 

This is the final step to implementing the 50 30 20 rule. When you approach this step, you will have more clarity on your income inflow and outflow. You will have the required details to avoid spending on unnecessary things. For example, you don’t have to dine out every weekend or watch movies. Once you have made the budget based on your needs, wants, and savings, start implementing it. Try to stay focused to gain better control of your finances.

Well, the explanation of the rule ends here, but the process does not. Once you make a budget, keep track of how consistent you are every month. It will also help you to modify the plan if needed.  

Examples of 50 30 20 Rule

Let’s understand this 50 30 20 rule with an example now. 

-> Suppose your after-tax income is Rs.50,000 per month. 

-> You have to divide this amount by a 50:30:20 ratio for needs, wants, and savings. 

• Rs. 50,000 X 50% = Rs, 25,000 = Needs
• Rs. 50,000 X 30% = Rs, 15,000 = Wants
• Rs. 50,000 X 20% = Rs, 10,000 = Savings

-> Once you get these numbers, you can get an idea of potential divergence from your current spending pattern. 

-> Over a period of time, try to increase the percentage of savings by eliminating unnecessary expenses. It will help you be disciplined and responsible for your finances. 

How Does 50 30 20 Rule Help in Your Savings?

Understand that managing our finances is not as intimidating as you think. By using this simple 50 30 20 rule, you can handle your budget in a very efficient way. Once you have categorized the list of items that fall under the needs, wants, and savings category, the task is done more than half. 

If you have determined an appropriate amount for needs and wants every month, it will help you to keep expenses in control and compound your savings. You can easily find areas where you can minimize your expenses using the 50 30 20 rule. For example, if your commuting method is hiring a private taxi every day, you can opt for public transport or a shared taxi. This will reduce your expenses under “needs,” and you can increase the share of savings. The same can be done for each aspect of wants. 

The idea is not to stop enjoying your life but to focus on maintaining the same level of comfort in the future by increasing your savings. In the long run, as your investment amount grows, you earn higher compounding returns and can create wealth. 

Difference Between 50 30 20 Rule Vs. Other Budgeting Methods

There are many rules of budgeting that help you diligently plan your finances. Each rule has its own essence, and you must evaluate your own constraints to choose the rule that has the highest upside in the future. 

Conclusion

Once you figure out your lifestyle and successfully implement the 50 30 20 rule, you can gradually increase your saving percentage. Though the rule is read as 50% wants, 30% needs, and 20% savings, you are free to customize it based on your requirements and preferences. Spending and savings differ from person to person, so decide the ratio that benefits you the most.