What is the 50/30/20 Rule of Budgeting

The 50-30-20 rule of budgeting is one of the most efficient and straightforward formulas which allows individuals to take a balanced path towards achieving financial goals. Senator Elizabeth Warren introduced this effective budgeting principle in her book “All Your Worth: The Ultimate Lifetime Money Plan”.

The rule states that the best way for an individual to spend his income after tax is to divide it strategically into three categories: Needs, wants, and savings. The following is the percentage that one must allocate to the after-tax income to gain maximum benefits.

50% on needs

30% on wants and

20% on savings

Sticking to this straightforward salary distribution rule will help you achieve your financial goals in the long term. Let us learn more about this rule in a detailed manner.

Those who want to achieve stable finances must follow the 50-30-20 budgeting rule, which allows you to spread your earnings strategically. This rule allows you to fulfil your needs, enjoy present luxuries, and secure your future.

Here are the three main components of this rule:

Needs : 50%

• The first part of this rule focuses on an individual's needs. An individual must allocate 50% of the income to fulfil his needs and those of his family. Needs are the necessary expenses that one cannot avoid and are required for survival. It is important to note that one must spend only 50% of the after-tax income on their needs.

• If you spend more than 50% of your income on necessities, then it is time to downsize or reduce your expenses. Some of the expenses that are covered under needs are as follows:

• Groceries

• Utility bills like electricity, house rent, etc.

• EMI payments for cars, appliances, etc.

• Rent and mortgages

• Medicines

• Education and other expenses

• If you need to reduce the portion of income spent on needs, you can opt to buy a modest car, move into a smaller home, or even take public transport to travel.

Wants: 30%

• Wants are also categorised as lifestyle expenses and must be allocated 30% of the after-tax income. While these are not essential for survival, they allow an individual to live a better life and enjoy it. By fulfilling the wants, an individual can live a particular lifestyle and benefit from the luxuries and services.

• The following expenses are considered as wants:

• Recreational activities or vacations

• Dining out

• Using branded products

• Buying latest gadgets

• Subscription-based facilities Netflix

• Wants are the things that enhance the standard of life and please you. It is one of the trickiest parts to navigate, as wants can be endless. One can curb unnecessary spending on wants in the following ways:

• Do not indulge in mindless shopping or buying expensive things which are not worthy.

• Avoid the EMI trap for buying. Instead, you can build a small fund to meet short-term goals.

• Space out your purchases, and avoid falling for the instant gratification trap.

• Before buying anything, it is best to compare the prices from various websites. Alternatively, you can wait for the sale season to begin to purchase things at a lower price.

Savings: 20%

• Apart from taking care of your present, it is crucial to make arrangements for the future and be prepared for unforeseen events. Though it is the most essential part of the 50-30-20 rule calculator, it is the most ignored one.

• You must accumulate three months of emergency savings to support yourself and your family in times of an emergency or financial crunch. At a later stage, you can shift the focus to retirement and work towards more distant goals.

• According to the savings formula prescribed by Elizabeth Warren, one must allocate 20% of the income towards investments. Unlike needs and wants, savings are a non-negotiable part and must have the top most place.

• Following are the savings that you can make to secure your future:

• Creating an emergency fund for uncertainties

• Investing in the stock market

• Contributing towards future goals like children’s education, marriage fund, etc.

• Buying term insurance or health insurance plan for yourself and your family.

• Investing in assets and schemes that offer tax deductions.

• Investing in the diversified portfolio through SIP to reduce losses

Now that you know about the rules of the 50-30-20 savings rule, let us see how to follow this budgeting formula to gain the maximum benefits. It is a simple formula which does not require any advanced understanding of finances or complex financial strategies.

• Know Your Monthly Income— The most basic requirement for following this rule is to know your monthly income after tax. You can look at your salary slip or check with the bank to find out your net income after tax.

• Know Your Expense Categories— Review your expenses from previous months and note the categories in which they fall. It will help you determine which expenses are included in the wants, needs, and savings categories. Once you know your spending pattern, you can plan further. It will also tell you about the present spending pattern and how far you are from the ideal one.

• Determine the Spending Limit for Each Category- After you know your monthly income and the category of expenses, you must calculate the exact amount that you can allocate to wants, needs, and savings. For this rule to work effectively, it is necessary that you adhere to the spending limits as per the percentage allotment.

• Monitor and Adjust— Once you follow the 50-30-20 rule to manage your finances, you can iterate the rule according to your financial objectives and other goals. As your income grows, you can increase or decrease your spending. However, it is essential to allocate at least 20% of income towards savings so your future can be taken care of.

Stay Consistent- The key to successfully following the 50-30-20 rule is to stay consistent and follow it month after month. Stick to the spending habit and avoid over spending even in case of excess income. Following this strategy consistently will bear the fruits of future security.

Understanding the 50-30-20 Savings Formula with an Example

Let us take help from an example to understand how the 50-30-20 rule works in real life and how you can make changes to the allocation over time.

• Income after tax= ₹30,000 per month

• 50% for needs = ₹15,000 per month (50% of 30000)

• 30% for wants = ₹9000 per month (30% of 30000)

• 20% for savings = ₹6000 per month (20% of 30000)

• If a fresher follows the 50-30-20 rule, he will save ₹72000 per annum. As income increases, a person can change the proportion of the allocations to gain more benefits.

• Here is an example of an experienced employee who follows the 40-20-40 rule. In such a scenario, he will be able to save more and enjoy more luxuries.

• Income after tax= ₹60,000 per month

• 40% for needs = ₹24,000 per month (40% of 30000)

• 20% for wants = ₹12000 per month (20% of 30000)

• 40% for savings = ₹24000 per month (40% of 30000)

• In the above example, we can see that though the individual is spending only 20% on wants, the amount is still higher than the 30%. Similarly, the amount spent on needs is also much higher, although the percentage has reduced.

• Thus, it is clear that as income increases, a person's lifestyle improves, and he still has more money for savings, which can be allocated for a better future.

Easy to Follow— The 50-30-20 rule is easy and straightforward to follow. It is a uniform rule that individuals from different socio-economic backgrounds can follow without any discrimination.

Strikes the Right Balance— The rule adopts a balanced approach and allows you to allocate amounts to both essential and non-essential spending. By adopting this budgeting rule, you can live a comfortable life at present and also be assured of a secure future.

Flexibility— Flexibility is one of the most significant advantages of this rule, as it can be altered and adjusted according to your financial condition and goals. You can modify the allocations according to the prevailing circumstances. For instance, those with less income can follow the 50-30-20 rule and as the income increases, they can modify the allocations.

Teaches You to Prioritise Important Expenses- As per this rule, majority of your income must be spent towards the fulfilment of your basic needs. It ensures your basic necessities are adequately provided for, reducing the scope for unnecessary expenses.

Provides Financial Security- The rule advocates saving a significant amount of earnings for the future. By adhering to this principle, you can save 20% of your income to create an emergency fund and invest in debts and securities for a financially strong future.

Makes you Goal-Oriented—By following the 50-30-20 rule, you become goal-oriented as you allocate a specific percentage of your earnings to savings and investments on a regular basis.

The 50-30-20 budget rule is a practical and effective way to save and distribute income smartly. By following it, you strike the right balance between your present needs and future security, allowing you to live comfortably and have a financially secure future.

While securing your future finances is essential, it is also vital to secure your health and that of your family members. You can do so by allocating some part of your savings towards health insurance plans.

Increasing inflation and the rising cost of healthcare facilities necessitate investing in a beneficial health insurance plan. Health insurance policies offer financial assistance and allow you to access the best healthcare facilities in times of medical emergencies.

Insurance is vital in securing your health and preventing financial strain when medical emergencies arrive unannounced. You must compare health insurance online and invest in a plan that is affordable and provides comprehensive coverage.

Tata AIG is one of the renowned and trustworthy insurance providers in the country offering the best insurance plans. Our health policies come with numerous add-on benefits and online renewal options. The plans cover end-to-end hospitalisation expenses so you do not incur any out-of-pocket expenses.