Budgeting is a simple and easy way of accounting for your income and managing the way you spend your money. Used properly, it can help you live well within your means and save up for the future as well.
One of the most commonly advised and used budgeting methods is the 50/30/20 rule. Not only is it easy to create, but this 3-step framework is also one of the simplest ways to handle your money the right way. It helps you identify your needs, wants, and other expenses so that you can utilize your income efficiently. You can even use online calculators to help you divide your income into these categories.
This article talks about what the 50/30/20 budgeting rule is, how it works, and how it can help you manage your finances well.
What is the 50/30/20 budget rule?
It’s just like it sounds. Your income is divided in the ratio of 50:30:20. This is what each segment is for:
- The 50% is for your needs.
- The 30% is for your wants.
- The 20% is to pay off debts and put into savings.
One thing to remember is that the income your divide should be your post-tax income. Reduce your taxes payable and only then divide it into this ratio.
Why does the 50/30/20 rule work?
Here’s why this rule works:
- The main reason why this rule works is that it is straightforward. Implementing and adapting to it is also simple, although you do need a bit of discipline to stick to it. You don’t have to list out all your expenses. Simply bucket your entire set of expenses into the 3 segments and you’re good to go.
- Another reason why it works is that it factors in debt and helps you pay it off at the earliest.
- It helps account for every dollar of your income. You will know exactly where you need to spend and where and how much of your money is being spent.
How does the 50/30/20 rule work?
Here’s how this rule works. The first step is to calculate your income after taxes. This won’t work if you divide your pre-tax income because you will have to pay taxes anyway and it will mess with your budget. Once you’ve calculated your after-tax income, follow the steps given below:
Set aside 50% of your income for your needs
Setting your needs and wants apart may seem tough, but it is not. A need is anything basic, anything required for you to survive. For example, food, clothing, and shelter. These are basic. Add to this utilities, basic travel expenses, etc. Keep 50% of your income aside for these expenses. What about dining out? Isn’t that food as well? Yes, but it’s not a necessity, it’s more of a luxury or a want. Don’t include those expenses in this list.
If you feel your needs account for more than 50% of your income, it’s probably time to reassess some of your expenses. For example, how much rent are you currently paying? Is it possible to move into a cheaper place for a little while? How much does your monthly transport expense come up to? Are there cheaper options? Try making a few changes to fit this segment into 50%. If your needs are lesser than 50%, move the balance into the last bucket.
Set aside 30% for your wants
Your wants are anything more than your basic needs. For example, traveling, dining out, partying, buying expensive clothes, shoes, gadgets, cars, etc. Limit this to 30% at the most, never more. If your current wants are more, reduce them. Look for cheaper alternatives for the time being.
Set aside 20% for debts and savings
As a general rule, you should save up at least 10% of your income every month. This is just your regular savings. Apart from this, you also need to create an emergency fund containing at least 6 to 12 months’ worth of expenses. Use this bucket to clear off any existing debt as well. Once your debts are cleared, look at investing the rest in good investment opportunities.
20% is the bare minimum for this bucket. Try and add more to it. For example, apart from your regular savings and emergency fund, start saving up for your retirement as well no matter how young you are.
The 50/30/20 rule of budgeting is a great way to control your expenses and manage your income in a responsible manner. Track and assess your spending. Make changes if required. Most importantly, stick to the plan.
