Personal financial management is not a subject we learn at schools but is still the most important book we need to read daily throughout our lives. Managing, investing and spending your money is a skill that is gained and develops through years of growing up. The basic checklist to manage your monthly finances is budgeting.
We deal with the dynamics of budgeting every month and end up with a chaotic statement that is never as planned for. Hence it is imperative to know the basic rule of budgeting in order to manage your finances flawlessly.
The 50-20-30 is a popular and the most easier to understand rule of budgeting. It divides your actual take home or in hand, post-tax deduction, into three buckets. The rule was introduced by Harvard bankruptcy expert Elizabeth Warren and her daughter, Amelia Warren Tyagi in their book, “All Your Worth: The Ultimate Lifetime Money Plan”
According to the rule, 50 percent of your income is to be disposed of for your needs. The food, water, shelter, clothing, transportation and basic education along with gas and electricity fall under this blanket.
The 30 percent is spending on wants that are not survival based. In simple words expenses over dining, gifting, touring and entertainment team up in this segment. Also includes club memberships, gym fees, pets, cell phones, your dish TV connection etc.
The 20 percent income suggests for your financial goals. This may include paying your debts and savings or investments for future security.
What all of us clearly understand is Expenses minus our total available disposable income equals our savings. Hence the expenses can never go overboard. Clear enough the expenses always need to be lower than our actual incomes or expected future incomes too.
The rule advocates that you need to categorize all your expenses as per the three heads of needs, wants, and savings. However, a need for one may just be a want for another. Hence the budget segregation would mean different to different people. Like a person traveling abroad for work considers his international roaming telephone expenses as a need whereas the one traveling for a holiday abroad may look at this as a luxury expense. Same goes for the travel and entertainment expenses. Watching a movie for a critic is not an expense, it’s a part of his work. However, going to the cinema on a weekend still falls in the 30% segment for others. Moreover, when incomes rise your ‘wants’ may increase but ‘needs’ to a large extent still remain unchanged. Hence instead of increasing your need ratio, you can add little more to your savings bucket.
Bear in mind, although the 50-20-30 stands as a rule of thumb it is not a one size fits all case. Each one has different financial needs and the wants and needs balance is different.
So use the rule to prioritize your “needs”, limit your “wants” and make way for good savings.