Budgeting is one of the first steps recommended to anyone trying to get their personal finance in order and is generally considered as one of the key steps in Adulting 101.
Often however, people struggle to decide what’s a good amount to allocate to their expenditure and to their savings. Is saving 20% of my salary enough? How about 30%? Or 40%?
That’s why the 50/30/20 rule was created!
The 50/30/20 Rule
The 50/30/20 Rule essentially lays down a set of guidelines to follow to create a budget for yourself. It is split into 3 categories: Needs, Wants, Savings. Do note that income here refers to take-home income.
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Under Needs, we can allocate 50% of our income to this portion. This refers to things that are essential to survive. No, your Netflix subscription doesn’t fall under this category and neither does buying the latest Yeezy drop. This would include things such as:
- Housing payments
- Phone/Internet Bills
- Debt repayment
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Using the rule, we allocate 30% to our wants. These are non-necessities but seek to improve your standard of living. Yes, this is the right category for Netflix and those Yeezys! Expenditure that fall into this category can include:
- Electronic Gadgets
- Entertainment expenses
- Car modifications
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And the last portion goes to savings! Savings doesn’t just refer to a stash of money you keep to the side. It can refer to your emergency fund, any long term savings for future purchases or saving for retirement via investing. Endowment plans are also generally included in this category.
So, Why Don’t I Recommend It?
The 50/30/20 rule definitely sounds simple on the surface and it seems like a good way to keep everything in check.
The 50/30/20 Rule Indirectly Encourages Lifestyle Inflation
Notice how the 50/30/20 rule breaks up your take-home salary using percentages? So let’s take a fresh grad with a take-home pay of $3,000.
He spends $1,500 on needs, $900 on wants and saves $600. Sounds okay so far…
Well, what if he worked for another 10 years, and his take-home is now $7,000?
He spends $3,500 on needs, $2,100 on wants and saves $1,400.
In 10 years, the amount he spent on needs and wants have doubled and more! But logically, our expenditures won’t keep increasing and increasing. After all, there’s only so many needs that most of us will have, right?
So where does the excess from needs go? To wants, of course! Naturally, if we have it budgeted but we find out that we don’t need it, many will just spend the excess and keep the 20% savings as budgeted. This is also why many who do not budget and track their expenditure often find themselves at the end of the month with little to nothing left from their paycheck.
This method of budgeting therefore causes its users to increase their expenditures on wants as their income increases. This is known as lifestyle inflation.
In that same train of thought, keeping to the 50/30/20 rule through your working life doesn’t exactly push you to save more. Many FIRE proponents strive for higher income so that they can push up their savings rates to 70%, 80% and even 90% in really high income brackets. As you move up through your career, the 50/30/20 rule, you should instead aim to push your savings rate higher instead of letting lifestyle inflation take the wheel.
When is it Good Though?
Now, this is not to say that the 50/30/20 rule holds no value in personal finance. I do feel that the 50/30/20 rule is a good starter to budgeting. For people who are clueless about financial planning, saving 20% of their income is already a huge jump from where they used to be.
So for young adults who have just entered the workforce, I think 50/30/20 is a decent place to start.
But the limitations of the 50/30/20 rule should be kept in mind by its users and the 50/30/20 should be adjusted to suit the financial situation of the user as well. Those with higher incomes can set higher savings rates without overly stressing themselves out and those with special expenditures (e.g. long-term medication), have to make modifications for their own budgets to accommodate these arrangements.
Ultimately, personal finance is, as the name implies, highly personal to your own needs, desires and capabilities. There simply is no one size fits all solution for everyone as we all lead different lives.
So my advice to everyone would be to keep in mind your own financial goals and devise a budget that helps you get there and is sustainable. Tweak the details as you go along in your journey and you should be good to go!
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