The 50-30-20 Rule of Personal Finance

While certain regulations may be burdensome, others, like the 50-30-20 rule, may enable you to achieve financial freedom. The budgeting rule was made popular by bankruptcy law expert Senator Elizabeth Warren in her 2005 book, All Your Worth: The Ultimate Lifetime Money Plan, which she co-wrote with her daughter, Amelia Warren Tyagi. It provides a simple, clear strategy for daily spending and emergency savings.
The 50-30-20 guideline entails allocating your income as follows: 50% for necessities, 30% for wants, and 20% for savings. Simple enough, but before you determine this is the best budget strategy for you, take a few key factors into account.
Understanding the Rule
In reality the rule is extremely straightforward. You are required to divide your in-hand money into three portions; 30% of income is spent on wants, 50% on necessities, and 20% is set aside for savings and investments. By doing this, you will have established containers for everything and be operating inside each bucket’s legal limits. This will instil a sense of discipline while ensuring that you don’t sacrifice the standard of living or your long-term planning. Now that the concept is apparent, let’s look at how to divide your expenditure into three categories: needs, wants, and savings.
Breaking the 50-30-20 Proportion
Needs: 50%
The basic things you definitely need to survive or must accomplish in order to live are considered needs. The things you must do in order to live peacefully are known as needs. These include things like getting groceries and food, paying rent or a mortgage, paying insurance premiums, making the minimum debt payments, and other similar obligations.
This guideline states that you can utilise half of your after-tax income to take care of such expenses that are constantly on your list of things that need to be taken care of right away. If you do not make these payments, you risk getting into difficulty or accruing additional debt for the following month, which almost certainly entails interest charges for the late payment.
Luxuries like subscriptions, gym memberships, etc. are not listed in the section titled “Needs.” According to the 50-30-20 rule, you must eliminate certain items from your “Wants” list if you find that you are spending more than 50% of your after-tax income on needs. If that isn’t an option, your only choice is to live more simply and just have what is absolutely necessary and required. Your difficulties with lifestyle inflation and spending habits may all be solved by adopting a minimalist lifestyle.
Wants: 30%
Wants are the luxuries that money can buy, as the term implies. Simply put, these are not necessities for basic survival but rather something to strive for. This is also the most difficult portion to manage because wants are limitless. Wants are things that make you happy. A few examples include splurging on occasional meals, occasional trips to the movies, leisure travel, seasonal shopping, expensive grooming products, hobby classes, etc. As you can see, the list of “desire” is endless and, if left unchecked, might even eat into your finances.
There are various things you may do to control the wants section. First, refrain from engaging in retail therapy and spending money on pointless things. The second thing is to space out your purchases and resist the urge for instant gratification. If you want to purchase the new iPhone 14, for instance. Instead of getting into the EMI trap, start accumulating a tiny “shopping fund” where you can deposit money to cover your immediate needs.
Even while the “no-cost EMI” option seems appealing, there are additional fees that users are unaware of. Ignorance is not joy when it comes to money. Be aware that there are no free lunches; in the zero percent plans, the interest component is frequently disguised as a “processing fee” and charged to users.
As an alternative, a shopping fund will make it simple for you to build up the necessary corpus without having to pay a sizable sum all at once. Therefore, you can start saving for that iPhone by setting aside some cash in liquid funds rather than using the EMI approach.
You can invest in a liquid fund for 6 months to attain the desired amount, using 1 lakh (approximately) as the money you need to purchase the most recent iPhone. As the name implies, liquid funds give you the flexibility of rapid withdrawal like a savings account with a higher interest rate, so your money makes money for itself instead of sitting idle in your savings account.
Savings: 20%
The savings account is what will get you through the future while necessities and wants tend to your well-being in the here and now. Though it may be the most significant bucket, it is also the one that receives the least attention.
The 50-30-20 rule states that 20% of your income must be saved and then used for investments. Note that, in contrast to needs and wants, saving should be a top priority and should not be negotiable. Everything can wait, but your cash and investments absolutely must not suffer.
The context of our current day provides the explanation for why this is the most crucial financial category. We regularly switch occupations, and more people are choosing unorthodox employment as a result of the uncertain times. You need to have a safety net to fall back on in times of uncertainty for your retirement and any unanticipated events that can arise.
As a result, the savings account will keep you financially prepared to weather any ups and downs in the economy or your personal life. Use your savings wisely—that is the most crucial thing to keep in mind. Don’t place them in investment opportunities that have excruciatingly long lock-in periods and interest rates that hardly outpace inflation. Invest in opportunities that provide returns that outpace inflation and provide you quick access to your money without the need for complicated paperwork or early withdrawal fees. After all, what use is your hard-earned money if it doesn’t help you out when you need it?
You can try to dedicate additional money to the Savings section if you have effectively managed and stabilised your lifestyle. You can always modify this rule to fit your needs, but you must make sure that at least 20% of your post-tax income goes toward the savings part. The rule can then be read as 50%-Needs, 20%-Wants, and 30%-Savings, and so on.
The 50-30-20 rule will enable you to exercise caution in your financial dealings and make sure that all of their money is not simply gone. You will have more influence over how you wish to spend your money and thus become more aware of your spending habits once you are aware of the wealth inflows and outflows. To maximize the value of the money you earn, make sure to balance all the buckets in accordance with this rule.