The 50/30/20 rule: A simple guide to budgeting

A budget can help in better financial planning enabling you to know where your money is going and to allocate a portion of your earnings. Despite knowing its importance, for the majority of people a huge gap persists when it comes to its actual implementation.

Most people struggle to go beyond basic budgeting to lay out a plan for themselves to meet short-term and long-term goals effectively in a time-efficient manner. In such a scenario, the 50/30/20 rule comes in quite handy.

The 50/30/20 rule essentially categorises your expenses in three broad categories – needs, wants and goals. This income distribution plays a crucial role in budget allocation and helps in effective financial planning.

Let’s take a look at some simple budgeting tips advised by the experts under the 50-30-20 rule to help you kick-start your budgeting journey.

What is the 50-30-20 rule?

The 50-30-20 rule basically recommends putting 50% of your money toward needs, 30% toward wants, and 20% toward savings. It’s important to clearly understand what exactly qualifies as needs, wants or goals for a positive outcome.

Needs

Needs cover all the expenses for the essentials in life – be it groceries, water or electricity bills, rent or loan payments, essential healthcare expenses, children’s education expenses, phone bills, transportation expenses, among other things. Hence, everything that is considered to be a necessity of life without which you can’t survive is considered as “needs”.

The 50-30-20 rule says that a maximum of 50% of your after-tax income can go towards covering such mandatory expenses. Remember that you need to consider your take-home pay and not your gross income while calculating the 50% component for budgeting.

Wants

Wants include all the discretionary spending that is done to enjoy life. This can include multiple things like vacations, travel, shopping, dining out, entertainment, among other things.

It may be difficult to identify a ‘need’ from a ‘want’. The simple rule, as mentioned above, is to ask “whether you can survive without this expense or not?”, or “does this expense cater to a basic necessity or a lifestyle need?”.

Once you have done that, you can put the expense in the correct category and do budget allocation accordingly. The 50-30-20 rule allows you to spend 30% of your after-tax income on the ‘wants’ or the ‘discretionary expenditure’ to help you maintain a quality of life. This is a flexible component. This means that in case of emergency expenses or income fluctuation, the budget allocation on needs can be curtailed to create a surplus to meet other expenditures.

Goals

This category forms the savings component of your budgeting exercise. Once you have outlined your goals – which can cover short-term milestones like saving for a foreign vacation or home renovation as well as long-term targets like buying a house – you can put aside 20% of your after-tax income to park in various savings and investment vehicles.

This 20% of your income can be put into mutual funds, fixed deposits, provident funds, pension schemes, or stocks, depending on the requirements of your goals.

Conclusion

Despite the simplicity and popularity of the 50-30-20 rule, it is generally not recommended that everyone follows the principle blindly. The needs, requirements and priorities of every family may differ vastly from one another. Hence, it is important for you to make a fair estimate and tweak the rule and the percentages involved accordingly. For instance, someone reeling under debt may have to cut a significant portion of expenses on discretionary ‘wants’ and ‘save’ much more. Therefore, the 50-30-20 rule should be essentially seen as a guiding principle for effective budget allocation.