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 after-tax 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 serves as the ultimate lifetime money plan.
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 and the financial planning industry, having specialised in bankruptcy law. It’s genius in its simplicity. The 50/30/20 rule is a budgeting rule that divides your primary monthly expenses into only three major categories. You calculate your after-tax income, and you budget it into the following categories: needs, wants, and savings.
Let’s take a closer look at the three categories described in the 50/30/20 Rule.
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 the living expenses that are essential for your survival – accommodation costs (rent or mortgage), basic groceries, 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 or health care providers.
- Buying less expensive brands of clothes/food and consolidating debt to reduce debt repayment.
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, and other luxury spending habits. 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.
The remaining one-fifth of your after-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 equalising your savings and debt repayment (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 making retirement contributions and any other financial goals, like accumulating a down payment for your dream home, you may have with the help of the 50/30/20 rule.
Without adhering to an unfailing budgeting method like the 50/30/20 rule, most people attribute much too little of their monthly after-tax income to savings. This rule of thumb creates awareness regarding the sustainability of financial lives, and financial clients gain clarity on how they can reach their savings goals.
Calculate the total amount of money you receive into your bank account monthly. Reduce that amount by the estimated tax amount you pay each month. If you have a retirement plan associated with your job, inquire about the amount that is withheld each month and add it to your take-home pay.
Multiply your total take-home pay by 0.5 to get the spending amount for needs, by 0.3 to get the spending amount for discretionary spending, and by 0.2 to get the spending amount for savings. This basic rule will instate order and structure to your financial situation and help you manage credit card debt payments without resulting in anxiety.
You may find it helpful to make a list displaying three clear categories. List your monthly expenses under the appropriate category and check yourself to see if you are spending less than the allocated amount or if you need to assign additional money to specific categories.
Keeping track of your monthly expenses will help you identify areas where you can make appropriate adjustments. For example, if you underspend on wants, you can attribute more money to savings and debt repayment or prepare for your retirement income.
Including an emergency fund in your financial goals and planning is a sure way to execute good management of your personal finance. The money in an emergency fund will only be used in the case of an urgent occurrence, such as getting sick or getting in an accident, which will involve substantial medical fees.
The 50/30/20 budgeting rule will effectively guide you to grow and maintain your emergency fund. Particular needs and situations will determine the amount of money an emergency fund will contain. Some want to budget for three months’ expenses, whereas others will prefer to prepare for six months’ expenses in order to feel comfortable and secure.
Essentially, the 50/30/20 rule of thumb allows you to store money that serves as an emergency insurance policy. Therefore, if there aren’t many unexpected expenses throughout your lifetime, you will have a large sum saved in either cash or non-cash forms.
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 take-home pay.
If you want to become a big saver like Elizabeth Warren, the 50/30/20 rule for 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 and other luxurious spending habits.
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 certified financial planner will have no ulterior motive- choosing instead to work toward 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 help from a retirement income certified professional or a chartered retirement planning counselor 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.