In our society, everyone wants to be rich but most people cannot control their spending. Every person should have a budgeting plan, which means, how they manage their money which may be for the annual plan, quarter plan, or monthly plan.
A good budgeting Plan could help you achieve your personal financial goals. Budgeting and managing finance in your own hand.
But before reaching a budget, it is mandatory to know monthly after-tax income, monthly spending for living expenses, liabilities, rent, etc.
The easiest and smart budgeting rule is 50-30-20 which is a simple budgeting method. This budget method tells us how much money you need to keep in your savings and your daily expenses etc.
This budget method also helps to avoid overspending and build up your wealth.
What is the 50/30/20 Rule of Budgeting?
The 50/30/20 is the easiest budgeting technique that could help manage your money practically in a simple and sustainable way.
The budget rule of thumb is to divide your monthly after-tax income into three spending categories such as 50% for needs, 30% for wants, and 20% for savings.
This is not a hard and fast rule but a simple budgeting rule that helps to make a decent corpus in the future and track your financial goals.
You may make better use of your money by consistently maintaining a balance between three key areas of expenditure.
You can also save yourself the time and frustration of going into the specifics every time you spend by keeping track of only the three main categories.
Senator Elizabeth Warren popularized the '50/30/20 budget rule' (sometimes labelled '50 - 30 - 20') in her book "All your worth: The Ultimate Lifetime Money Plan".
The basic rule is to divide up after-tax income and allocate it to spending 50% on needs, 30% on wants, and 20% on savings.
50% for Needs
Needs are those expenses that you have to pay in daily life for survival. These include rent, groceries, bills, transport, insurance premiums, minimum debt repayment, etc.
Needs are essential expenses that you can't ignore. The few expenses are following
- Rent
- Groceries
- Utilities like electric bills, gas bills, etc
- Car of House EMI
- Insurance Premium
- Children Education Expenses
According to the rules, With all the requirements to meet, a basic standard of living consumes half of your after-tax income.
If you missed making any of these payments, You're probably in trouble or amassing more debt for the following month, which will incur additional fees for late payments.
For example, your father's monthly after-tax income is Rs 50,000. So you can spend Rs 25,000 per month. These expenses have to pay for survival that cannot skip.
But TV cable, Youtube subscription, eating at KFC, and entertainment expenses do not fall under these sections. Hence, there is a high chance that you may spend more than 50% of your after-tax income on your needs.
Despite the fact that this is unwanted, you can reduce your indulgences. In essence, you need to either look for ways to boost your income or find alternatives where you may scale back on your existing lifestyle.
30% for Wants
This is another aspect of this rule. Wants are those expenses that are not absolutely necessary for living but may want. It includes all costs that enhance your quality of life. Here are a few wants following
- Dining out
- Gym membership
- Travelling
- Netflix subscription
- Hobby
These items may still need to be finished. Most wants are costly and pricey and cost a lot of money. But there are also less expensive options.
Such as buying a Suzuki car instead of a BMW car. Similarly buying a Samsung phone instead of an iPhone.
Using the same example above, your father's monthly after-tax income is Rs 50,000. So, you can spend Rs 15,000 on your wants.
You may occasionally feel inclined to spend a lot of money to fulfil your desires. You can buy these things using cost-free EMIs or zero-processing payment plans.
However, nothing in this world is free. There are always a few hidden fees that we are unaware of.
Therefore, you might look to reduce these expenses if you believe that you are spending more than 30% of your income on wants.
This rule does not, however, require you to cease enjoying life by giving up things that make you happy. However, this rule helps you to track and manage your expenditure.
20% for Savings
The last one is the most essential component in this rule of budgeting. The remaining 20% of your net income is allocated for savings and investment or also loan repayment.
Hence, consistently putting 20% in savings will meet your financial goals. This rule helps you to achieve your financial goals in the future and create more wealth for yourself.
The portion of funds can be used for
- Emergency Funds
- Investment in stocks, mutual funds, ETFs, etc.
- Loan Repayment
- Tax savings schemes like PPF, ELSS
Planning for long-term goals like Children's education, marriage, retirement, etc.
Using the same example above, your father's monthly after-tax income is Rs 50,000. So, you can put Rs 10,000 in savings for financial goals. Savings is the most important part of your income.
Always strive to save more money over time and make sure you're building up finances for your financial objectives.
Additionally, this component of the funds must be carefully planned. You might begin with a specific amount set aside for unforeseen circumstances like personal or medical emergencies.
Once you have emergency funds available, you can invest your money in a variety of investment strategies.
However, you must make sure that these investment plans can deliver returns that consistently outpace inflation and offer you access to your money whenever you need it.
How to use the 50/30/20 Rule for Budgeting?
Most people spend more than they save, often without even realizing it. The 50/30/20 rule of thumb might help you become more conscious of your spending patterns and prevent under- and overspending.
You can increase your savings for the things that are important to you by spending less on the things that aren't really important.
Calculate your monthly income:
The first step to calculating the 50/30/20 budgeting rule is adding how much money receive in your bank account each month from your job, business, etc.
If you have a retirement plan at work, find out how much is withheld and add that amount to your take-home pay. If you pay taxes your monthly income reduces.
Calculate a spending threshold for each category:
Multiply your take-home pay by 50 (for needs), 30 (for wants), and 20 (for savings goals) to see how much you should ideally spend in each category.
Plan your budget around these numbers:
Consider these three spending areas as "buckets" that you can fill up with regular outgoings.
Check to determine if you are spending less than the monthly spending goals you set in the previous stage by listing and totalling your monthly expenditures under each category they belong in.
Follow the budget:
Keep monitoring your monthly expenditures and adjust as necessary to stay within your budget moving forward.
Why are savings important?
The 50/30/20 rule helps individuals to track after-tax income and build a large amount of corpus. Every person should create emergency funds for job losses, unexpected medical expenses, unforeseen expenses, etc.
Savings are an important step for retirement for living longer. Calculating your retirement needs and making progress toward that amount from an early age can guarantee a relaxing retirement.
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