What is the 50/30/20 rule?
The 50/30/20 rule is an easy budgeting method that can help you to manage your money effectively, in a simple and sustainable way. The basic rule of thumb is to divide your monthly after-tax income into three spending categories:
- 50 percent of the earnings after-tax should be used towards necessities.
- 30 percent of the money should be spent on luxuries or wants/desires.
- 20 percent of the money should be saved and invested towards your financial goals.
By regularly keeping your expenses balanced across these main spending areas, you’ll be wiser about your spending habits and avoid overspending. And with only three major categories to track, you’ll save yourself the time and stress of digging into the details every time you spend. Sticking to the 50/30/20 rule will make it easier to stay on track to reach your financial goals, whether that’s saving up for a rainy day, or to clear the existing debt.
How does the 50/30/20 rule work?
Spend 50% of your money on needs
Needs are expenses that you can’t avoid – payments for all the essentials that would be difficult to live without. 50% of your after-tax income should cover your most necessary costs. Needs include:
- Living expenses
- Insurances (Life, Health, Motor, etc.)
- Loan repayments
- The essential bills like electricity and groceries
- School Fees for the children
For example, if your monthly after-tax income is ₹ 20,000, ₹ 10,000 should be allocated to spend on your needs.
Use 30% of your money on wants
With 50% of your after-tax income taking care of your most basic needs, 30% of your after-tax income can be used to cover your wants. Wants are defined as non-essential expenses – things that you choose to spend your money on, although you could live without them if you have to.
- Dining Out
- Gym Membership
- Entertainment subscriptions (Netflix, Amazon Prime, Disney+ Hotstar, etc.)
- Groceries (other than the essentials)
- Buying the latest gadgets
Using the same example as above, if your monthly after-tax income is ₹ 20,000, you can spend ₹ 6,000 for your wants. And if you discover that you’re spending too much on your wants, it’s worth thinking about which of those you could cut back on.
Following the 50/30/20 rule doesn’t mean not being able to enjoy your life – it simply means being more responsible with your money by finding areas in your budget where you’re needlessly overspending. If you’re confused about whether something is a need or a want, simply ask yourself, “Could I live without this?” If yes, that’s a want, not a need.
Stash 20% of your money for savings
With 50% of your monthly income going towards your needs and 30% allocated to your wants, the remaining 20% can be put towards achieving your savings goals or paying back any outstanding debts. Although loan repayments are considered needs, any extra repayments reduce your existing debt and future interest, so they are classified as savings. Consistently putting aside 20% of your pay each month can help to build a smart savings plan such as an emergency fund, a comprehensive, long-term personal financial plan, or even a down payment for a house. If you bring home ₹ 20,000 after tax each month, you could put ₹ 4,000 towards your savings goals. In just a year, you’ll have saved close to ₹ 50,000.