Are you struggling with budgeting? Did you hear about the 50/30/20 budget rule and are wondering what is it all about?
Have you read about all the budget categories you need to make and tried a few different budgeting methods?And yet you still fail to find one that works for you.
I know that feeling. I have been there too. I was at a point where I used to shy away from budgeting because it was just so overwhelming.
And the thing is, you have heard it before. The first step to managing your money is to Create a Budget. But you have no idea where to begin. Maybe you even started with the budgeting categories and while that worked for you for a while, you’re still wondering whether you’re saving enough or not.
If you have no clue, what budget categories we’re talking about here are The Only 6 budget categories you need to manage your finances better.
And the fact is, there is no budget that can fits everyone’s individual needs. We are all unique people and so are our priorities and our needs and wants.
And that’s where the 50/30/20 budget method comes into play. This is a method that you can change according to your own priorities ( we will talk more about it later in the post), but knowing the basics of the 50/30/20 budget method will help you get on top of your finances.
WHY YOU need a budget:
Making a budget is the first step towards financial freedom. No matter what your financial goals are or where you are in your financial journey, budgets are crucial.
So much so that when you ask anyone their No.1 Money advice, chances are they’d say “Create a Budget”.
Having a budget allows you to look at your expenses, track your spendings and manage your savings. You’ll be surprised to see how much money you can save simply when you know where you’re spending it.
As they say ” Whatever gets measured, gets managed”, so of course tracking your spending and budgeting are crucial for better financial management.
the 50/30/20 Rule:
In simple words, the 50/30/20 method is a tool that tells you where to put your money, by breaking it into three simple categories your needs, wants and savings.
Simply said, Ideally you should spend 50% of your income on your needs, 30% of your income on your wants and the rest 20% in savings. But these values may differ if you are working towards an early retirement or if you are looking to buy a house or are paying off debt. We will talk more about how you can tweak this according to your priorities. Let’s talk about the basic principle first.
WHAT IS 50/30/20 Budget rule:
The 50/30/20 method breaks down your ideal spending of your after tax income into 3 major categories, that are:
- 50% of your income for your needs like electricity, rent, groceries etc: This category will include the essentials like health insurance, car insurance, your gas bill, water bill, groceries and basically any expenses you can not live without. And no, your daily starbucks drink does not count.
- 30% of your income for your wants like travelling, pedi-manis, take aways and all the other “luxuries”: This category includes all the luxuries you want in your life like going out to the movies, eating out, going to the spa or salon, your netflix subscription, your phone bill etc.
- 20% of your income for your savings or paying off debt
And while budgeting is never as simple as that, it’s a great framework and a great starting point for you. Let’s see how you can use this budgeting method in real life.
How to use 50/30/20 Budget rule:
Okay so I have your interest. Do you want to give the 50/30/20 rule a try? Here is what you will have to do first. Calculate your income after tax, which is your take home income and then allocate 505 for your needs, 30% for your wants and the rest for savings. Let’s discuss it into more detail.
STEP 1: CALCULATE YOUR INCOME AFTER TAX
The first step is calculating your income after tax. This should be fairly simple if your pay for each month is fixed, which would be the case if you’re working in corporate and have a fixed pay structure.
Most corporates will deduct the taxes at their end on a monthly basis after you have submitted the required proof of savings and other documents. I find that’s the easiest way to do your taxes as you don’t have to worry about the calculations.
For those of you for whom income varies on a month to month basis, you’ll have to do the calculations every single month. There is no way around it, I am sorry.
So if you are working as a freelancer and are responsible for paying your own taxes, calculate your total taxable income, which is the net revenue minus the expenses. And when you have the taxable income, deduct the taxes you need to pay and you’ll get your taxable income.
Make sure to put your taxes in another account, so you don’t end up spending that money and are not struggling when the tax season comes.
WHAT are needs and wants?
Before we go to the next steps, we need to understand the difference between the needs and wants. Needs are simply things you can not live without. It’s the money you pay for rent and the food you eat.
And wants are things that are a luxury, but you still spend money on. Like going out to the movies and dining out.
So whenever thinking about whether an expense should be categorised as a need or want, ask yourself “How will my life look without it?” or “Does not having this affect the basic quality of my life?”
Allow me to explain a bit more.
Not having money to buy champagne means not being able to meet a want, while not having enough money to buy your groceries for the week, means struggling to meet your needs.
You get the point right?
So a luxury hand bag is a want. Having the newest model of Iphone is a want. These are not things without which you can’t survive.
So your primary needs as a human are considered your needs. And anything above that is considered a want.
STEP 2: LIST YOUR NEEDS & GET IT TO 50%
The next step is to list down all your needs and to make sure you are not spending more than 50% of your take home income on your needs. Your needs are things without which the quality of your life will suffer.
So write down all the “needs” expenses you have. This will include the rent you are paying, the money you spend on electricity and water bills, any health insurance or car insurance that you’re paying yearly (pro-rated), and groceries etc.
And yes, these days wifi does come under a need because most of us are working from homes and we wouldn’t be able to do so without the wifi connections.
But no, your Netflix subscription doesn’t count as a need. Sure you could argue that the quality of your life will be affected without Netflix, but I’d say you’re being dramatic.
Ways to bring your needs down to 50%:
And once you have listed down all your needs, calculate the toal and see if it comes less than 50% of your take home income. If it does, good for you, and if not, you need to make some changes.
Are you paying sky high rent that you can’t really afford? Maybe you need to consider moving or getting a roommate and subletting. So take these necessary steps. And make sure you are spending no more than 50% of your take home income on your needs.
STEP 3: List down your wants and bring them down to 30%
Your wants are things you can live without, but would rather not.
After all you work hard at your job to be able to afford some luxuries in your life. And that’s perfectly okay, as long as your wants aren’t more than 30% of your take home income.
This includes things like eating out, going out to movies, getting pedi-manis done, getting a blow dry, buying new clothes and so on. You get where I am going right?
The quality of your life wouldn’t suffer if you don’t buy that new dress you’re seeing everywhere on Instagram. But you still WANT to buy it.
So list down all your wants and bring them down to 30% of your total in hand income. Yes this is where your Netflix comes in. And again, if your wants are less than 30% of your in hand income, that’s great. And if not, time to cut back on some luxuries and bring it down to 30%.
The good thing about cutting on your wants is that it is fairly easy, even though you think it’s not. All you need is a simple mindset shift. You need to understand how important it is to develop good money habits and not spend the money you don’t have.
And cutting down on some of these luxuries will not affect your life in any way, even though right now you think it will.
Step 4: Calculate & Allocate 20% of your income towards Savings
This is honestly the best part about the whole 50/30/20 rule. Each month you’re making sure that you’re saving at least 20% of your take home income.
I often start with the savings whenever I receive a paycheque.
This is also where you debt payments go in. So if you are working towards paying off a debt, all your money should go towards that after you’ve built up an emergency fund.
HOW MUCH MONEY DO YOU NEED IN EMERGENCY FUND?
While the financial Guru Dave Ramsey says you should save $1000 as an emergency fund, I save about 3-4 months of my expenses. I know some people recommend saving about 6 months of expenses. this way you are making sure you aren’t going into more debt in case of any emergencies.
So calculate your needs for a month and multiply that number by 3. Save that money in an emergency fund. And when you’re done, start allocating the rest of your savings towards debt payments. Ideally you should start with the debts that have the highest rate of interest. But it depends from person to person.
If you don’t have to worry about paying off debt (lucky you), then consider investing a part of your savings so that it can bring you interest. There are so many investment options to choose from. I always make sure to invest in a couple of mutual funds and towards my retirement fund as well.
IS 50/30/20 Budget rule the right fit for you?
Having duscussed the 50/30/20 rule, do you think it is the right fit for you?
Because it won’t be the right fit for everyone.
If you are someone who struggles with managing money and doesn’t end up saving much, it can be a great place to start. Because this method makes sure that you save at least 20% of your take home income each month and that definitely adds up in the long run.
Or if you struggle with making a budget and all the different budget categories feel intimidating to you, this rule is a great framework. Because there are just 3 budget categories you need to worry about.
However, if you are working towards an early retirement, then saving just 20% of your income each month might not be enough. In that case, your focus might be on reducing your expenses to as low as possible and saving more than 50% of your income.
You can of course tweak the percentages as your priorities change. When I was paying off my student debt, I was saving about 45% of my net in hand income. It was a challenge but I knew I needed to adopt a frugal lifestyle to be able to do it.
And now I am back to saving about 35% of my income, which works for me. So change the percentages according to your priorities and make the 50/30/20 budget method work for you.
50/30/20 budget method is fairly simple as you need to worry about just 3 budget categories. And while the exact percentages may not work for everyone, it provides a great framework.
It is a really simple budgeting method and that’s why a lot of people love it. And I love how easily you can make the changes and customise it according to your financial goals.
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