From speaking to my clients, I know that budgeting personal finance is something that many people find extremely difficult. But, like life, managing your finances is all about balance. After you’ve met all your bills, you have to decide how to use your leftover income. For example, suppose you’re finding deciding how much of your hard-earned money you should dedicate to the pursuit of pleasure, how much you should put away to secure your financial future and how much to set aside as an emergency fund. In that case, the 50/30/20 Rule is a simple way to tackle the dilemma.
The 50/30/20 Rule
The 50/30/20 Rule of budgeting approach to managing income is usually credited to Senator Elizabeth Warren, a woman who presumably knows a bit about financial systems, having specialised in bankruptcy law. It’s genius in its simplicity. You calculate the income you have left after-tax, and you budget it into needs, wants, and savings:
Let’s take a closer look at the three categories described in the 50/30/20 Rule.
Needs – spend 50% of your monthly income on these:
Under the 50/30/20 budgeting strategy, the majority of your income should go to paying for your needs. No, we’re not talking a night on the cocktails at Bar Rouge, your morning Starbucks or even your Netflix subscription! Needs are those things that are essential for your survival – accommodation costs (rent or mortgage), food, transport to work, general and health insurance and utility bills. If you have debts, the minimum debt repayments also count as a need.
This budgeting rule assumes you can cover all of these expenses with 50% of your post-tax income. If your monthly income is not enough, you need to look at areas of your life where you can cut back to save money. Ideas include:
- Downsizing to a smaller home.
- Switching utility providers.
- Buying less expensive brands of clothes/food and consolidating debt to reduce minimum payments.
Wants – spend 30% of your monthly income on these:
Wants are things that enhance your life but that you could live without, and they fall under the second part of the 50/30/20 Rule. They include meals out and nights on the town, concerts and sporting events, gym membership, weekends away and holidays, the latest gadgets, designer trainers/handbags/suits etc. If it’s not essential to your survival, it’s a want, not a need.
They are also upgrades to a level above that which you require. For example, while you need to eat, you don’t have to spend money at the most expensive grocery stores. The food from a less expensive grocery store will sustain you just as well and won’t put a big dent in your savings. You might need a car, but a Mercedes S-class is not a necessity. A Nissan will get you from A to B just as effectively.
Using 30% of your budget, based on the 50/30/20 Rule, on luxury products and services ensures you have enough money to live comfortably without spending too much of your money on unneeded expenses.
Savings – dedicate 20% of your net income to this (at least!)
The remaining one-fifth of your post-tax income should be channelled into savings and investments. If you have debts, the first thing to do with this savings element of your income is to start paying off the principal (rather than simply meeting the minimum payments, which are classed as needs) until you get them cleared.
The 50/30/20 Rule recommends that you should first concentrate on accumulating an emergency fund in a savings account if you’re debt-free. This should correspond to about six months of essential expenses (equivalent to your needs as outlined above) and is the budget you use to get through costly unforeseen events such as being made redundant or unexpected medical bills. Once that is done – happy days! – you can start to build your wealth by investing for your retirement and any other financial goals you may have with the help of a savings rule.
What is the Importance of an Emergency Fund?
Setting your financial goals to include an emergency fund shows good management of personal finance. Money in an emergency fund is used in the unlikely instance that you get sick or become involved in an accident and need to pay untimely bills. The 50/30/20 budget rule is an effective way to guide you in maintaining and growing an emergency fund.
Emergency funds vary by individual and their situations; therefore, they do not need to have the same amount of money held in them at one time. For example, some people may prefer to budget three months worth of expenses, while others will accumulate up to six months worth of expenses before they feel comfortable at keeping money saved up in this way.
The 50/30/20 Rule of budgeting lets you store money in emergency funds that act as an insurance policy, so the fewer unexpected costs that come up throughout your life, the more money you will have saved. Emergency funds can be held in both cash and non-cash forms.
Benefits of Professional Financial Advice
If you have trouble using the 50/30/20 budgeting approach for your income, then the chances are that you will be unsure about the best way to invest your savings. So it is worth taking professional advice over personally researching how to budget your money.
If you want to become a big saver like Elizabeth Warren, 50/30/20 budgeting is what many experts recommend. A financial adviser will help clarify your financial goals and put together a retirement savings plan to attain a comfortable life when you stop working, even if that seems like a remote prospect right now. Then, once that is sorted, you can treat yourself to that S-class!
When it comes to personal finance, many people feel the need to take the reins into their own hands by trying a certain budgeting method. After all, they might reason, nobody knows your financial position better than yourself, and therefore nobody else can offer you advice on how to budget your money. But, unfortunately, personal research can often be misleading as most resources are biased by a third party interested in selling a product or service. In contrast, a financial adviser will have no ulterior motive- choosing instead to work towards their client’s best interests.
Experiencing trouble with using the 50/30/20 Rule to budget your income means it is worth seeking the services of a financial adviser who will help clarify your financial goals. The benefits of professional financial advice are that you can’t afford to get it. In addition, if you don’t already have a retirement plan, getting some professional help will reassure you that your budget and savings are on track and will allow you to enjoy life more comfortably.
Feel free to email me at firstname.lastname@example.org if you need assistance to get your financial planning sorted, whatever stage you are at in the process.
I work as a Financial Planner with expat clients to meet their financial planning needs and goals, with a focus on adequately protecting expats & their families, and helping people to grow their savings over the long term. I strongly believe in building meaningful and lasting relationships with clients to ensure the best client outcomes are achieved.