50-30-20 Rule

Budgeting is an integral part of financing. But it’s often seen as time consuming, boring and complex. But surprisingly the best budgeting tips are often the most simple. Just like in this case.

Originating from the 2005 book, “All your Worth: The Ultimate Lifetime Money Plan” written by Elizabeth Warren, the 50-30-20 rule is a smart and straightforward monthly budgeting method that tells you exactly how much money to pour into your savings, needs and wants each month. With a clear big-picture overview of your budget for the month, you can confidently avoid overspending and consistently build up your savings.

The rule is to divide your monthly after-tax income into three categories. 50% for needs, 30% for wants and 20% for savings and investment.

50% for Needs

50% of your after-tax income should cover your needs, which are expenses that you can’t avoid. It includes:

  • Rent
  • Groceries
  • Utilities
  • Education
  • Insurances
  • Loan repayments or EMIs

If your needs overshoot the allotted budget then, for a healthier financial life, the author suggests looking for cheaper alternatives which may include shifting to a cheaper apartment or looking for another vegetable vendor.

30% for Wants

30% of your after-tax income should be used to cover your wants. Wants are non-essential expenses, things that you choose to spend on although you could live without them. It includes:

  • Shopping
  • Vacations
  • Entertainment subscriptions
  • Groceries (other than essentials)
  • Dining out

If you have been unconscious of your money in the past then you may find yourself spending too much on your wants and overshooting your set budget. Or you might find yourself confused between a want and a need, at that stage ask yourself, “could I live without this” if the answer is yes then that’s a want not a need.

20% for Savings

With 50% of your monthly after-tax income going towards your needs and 30% allocated to your wants, the remaining 20% must be saved and then utilized through investments. This includes adding money to an emergency fund in a bank account, investing in mutual funds or stock market.

You should have at least 3 to 6 months of your monthly salary in your emergency fund in case you lose your job or an unforeseen event occurs. After that, focus on retirement and meeting other financial goals down the road.

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