50/30/20 Rule

The 50/30/20 rule is a personal finance thumb rule which states that a person should pay 50% of their income after tax for needs or necessities, 30% for wants, and 20% for investments and saving. It is a rule for clever budgeting, which describes the ideal way for a person to spend their money. This rule aims to budget and allocate income into three categories: needs, wants, and savings.

The rule is oddly simple and helps in creating a mindset of disciplined spending and saving while at the same time providing room to enjoy life too. The main aim is to make the person financially independent and cultivate responsibility. The rule makes it easier for individuals to focus on their long-term and short-term goals.

• The 50/30/20 rule states that an individual's after-tax income has to be divided into three parts. The first 50% of income should be used for needs or necessities, 30% for wants and desires, and 20% for savings and investments.
• The rule is easy to budget, provides clarity, flexibility, and balance, and helps people achieve their financial goals.
• It helps in creating a mindset of disciplined spending and saving while at the same time providing room to enjoy life too. The rule makes it easier for individuals to focus on their long-term and short-term goals.

The 50/30/20 rule of budgeting is the go-to mantra for personal finance. This simple rule states that individuals should divide their after-tax income into three parts. The first 50% of income should be used for needs or necessities, the next 30% for wants and desires, and the remaining 20% for savings and investment. This way, they can allot a particular limit on the amount, and the spending should be within these limits. 

A detailed breakdown of 50-30-20 components is as follows:

#1 - 50% For Needs

Needs are things that are necessary for survival. They include paying bills, groceries, food, mortgages, insurance premiums, debt repayments, fuel, electricity, etc. Undoubtedly, these expenses must be paid, or the quality of life will suffer. A person can allot half of their income to bare necessities. Those payments, if not paid, will land the person in trouble, such as not paying a water or electric bill or delaying debt repayments, such as interest on mortgage payments or late fees on insurance premiums.

One important thing to note is that these payments do not include luxuries. Therefore, expenses like a gym membership, Netflix subscription, or similar payments do not contribute to the necessities. To stay on track with the rule, individuals must sacrifice luxuries unless they are extremely important. Adopting a minimalist lifestyle can help individuals stay on track and also help control their spending habits.

#2 - 30% For Wants

Any non-essential but desirable item, such as movies, outings, shopping, and vacations, is considered a want. This section of money allocation is to be spent on wants. This means that one does not need it but wants it. These expenses can be foregone if desired since they are not an absolute necessity for survival. Therefore, individuals must carefully allocate money to this section, as human wants are endless. However, treating oneself to a fine dining experience or buying a luxury item occasionally is acceptable, provided one keeps track of the expense.

This section can also include expenses related to a new hobby, traveling, or other splurges. However, planning can help one navigate this path with ease. For example, suppose the individual has to purchase additional fancy furniture for their house; they can start a small purchase fund to save money little by little. This helps individuals escape EMIs. In short, practicing restraint and not falling for instant gratification will help individuals sail through expenses.

#3 - 20% For Savings

This allocation section is focused on the future and, therefore, critical. Therefore, investments and savings are of the utmost importance and non-negotiable. Any number of desires can be sacrificed to meet the amount required here. It is the action of saving for a rainy day and will come in handy in periods of uncertainty. In addition, it helps bring stability in personal and professional ups and downs. Therefore, no matter how small the amount is, it should be meticulously invested.

There are a variety of ways one can do this: they can opt for SIPs or invest in ROTH IRAs, mutual funds, or other schemes. Building an emergency fund (3-6 months of salary) is ideal. The requirements may vary from case to case depending on the family size, family background, expenses, etc. The next ideal option would be to save for one's long-term goals, such as retirement or children's education; hence, it is important to start early.

SIPs ensure disciplined investing and help individuals stay on track. Another advantage of SIPs is that one does not fear market timing. So, it is possible to make small periodic payments to accumulate a sizeable amount over a long period through compounding. However, investments are subject to market risks, and individuals shall make decisions accordingly.

Check out these examples to get a better idea of the rule:

Example #1

Danny has a monthly income of $22915 after all tax deductions. He decides to utilize the 50/30/20 budget rule. So, he used a 50/30/20 rule calculator, and this is how he allocates his income:

50% of $22915 = $11458

30% of $22915 = $6875 and;

20% of $22915 = $4583

Thus, he can spend $11458 on his needs, $6875 on his wants, and $4583 on his investments and savings.

Example #2

Liza has a monthly income of $5000 

Using an online 50/30/20 rule calculator, she finds the following allocation:

50% of 5000 is $2500

30% of 5000 is $1500 and;

20% of 5000 is $1000

Let's look at her monthly 50/30/20 budget allocation:

Necessities:

Wants:

Savings and investments:

The main benefits of the 50/30/20 rule of money are as follows:

#1 - Easy To Budget

It is a simple and efficient rule that makes budgeting easy for anyone. By opting for this rule, an individual knows that the allocation has to be done in steps of 50%, 30%, and 20%. It is only from here that the expenses have to be allocated.

#2 - Clarity

Individuals know their monthly spending limits and how to fit their expenses within these brackets. It helps them realize what is necessary and what is not.

#3 - Flexible

People have different income levels, and their expenses vary as well. However, the rule is universally applicable and helps all groups of people focus on controlling their spending habits.

#4 - Provides Balance

Under the rule, apart from provisions for needs and savings, the section for individual wants focuses on enjoying life. Spending on things one loves is also a form of relaxation, and it is a bonus if the budget helps one do it easily.

#5 - Helps In Achieving Financial Goals

This rule helps allocate the necessary amount to meet short-, medium-, and long-term goals. Here, monthly budgeting is sorted, and the individual does not have to consider different saving methods. The plan helps them be disciplined and focused.

 A few budgeting alternatives to the 50/30/20 rule of money are given below:

1. Cash-only or envelope budgeting: In envelope budgeting, individuals withdraw cash from banks and put it aside in categorically placed envelopes.
2. Zero-based budget: An account is maintained for every dollar spent in this budget type. In other words, there is a plan for every dollar.
3. The 60% solution: Under this, 60% of income is allocated towards needs, and the rest 40% is divided into four equal categories of 10%. Those four categories include long-term savings, short-term savings, retirement, and money for wants.
4. Sub-savings account method: Under this, a separate savings account is created for different goals. The amount and period are predetermined.
5. 80/20 budget rule: 20% is readily stacked away as saving in this type. The remaining 80% can be spent as one wishes; 50/30/20, 60/10/10, etc. 
6. 70/20/10 rule: Under this rule, 70% is allocated for Essentials and necessities, 20% for savings, 10% for debt repayment, etc.

This has been a guide to what is 50/30/20 Rule. Here, we explain the topic in detail, with its examples, calculation, alternatives, and benefits. You can learn more about accounting from the following articles –

• Debt Management
• Loan Repayment
• Debt Restructuring