The 50/30/20 Rule: A Simple Way to Manage Your Finances

Managing the finances, does that feel like as difficult as scaling Everest? Especially with so many different budgeting methods and strategies? Don’t worry, there’s a simple and effective approach called the 50/30/20 rule that can help you take control of your money without having to do complex calculations or without strict restrictions. Let us see what the 50/30/20 rule is, how it helps you and the way you can use it better your financial management.

50/30/20 rule – What is it?

The 50/30/20 Rule is a financial planning tool that guides on how to distribute your after-tax income into different categories:

• 50% stands for Needs: The first 50% is for the key expenses that are necessary for survival and day to day living.
• 30% stands for Wants: This 30% is for those things which you want to have and enjoy having but are not essential for day to day living
• 20% for Savings and Debt Repayment: This category focuses on building one’s financial security by saving for the future and paying down debt.

What is the 50/30/20 mechanism?

Your after-tax income is the base for this 50/30/20 rule. After-tax income means the money you will have in hand after taxes and other mandatory deductions are taken out from your income. Let’s understand each category.

50% – The Needs:

This portion of your income is earmarked for your essential needs and those things needed for your survival. These are things which you can never ignore and cut down from your expenses, if done so, it would impact your life significantly.

Some examples are:

• Accommodation: It could be rent or an EMI of your housing loan, maintenance and taxes on house.
• Amenities: Expenses on electricity, water, gas and internet.
• Travel and transportation: Payments for petrol/diesel, public transportation fares, and vehicle insurance.
• Groceries: Essential food items and household supplies.
• Healthcare: Doctor visits, and prescription medications.

30% – Wants:

Wants are expenses for things you enjoy but are not essential for survival. They add comfort and entertainment but can be adjusted or eliminated if needed. For instance, home workouts can replace a gym membership, cooking at home saves dining costs, and watching sports on TV is a cheaper alternative to game tickets. Wants enhance life’s convenience but can be reduced to prioritise needs and savings. Examples include dining out, luxury items, vacations, and premium subscriptions. Examples of wants are. Examples of wants are:

Rewarding your taste buds: Having dinners at restaurants or ordering your favourite food.

• Entertainment: Holiday trips, movies, concerts and even gaming.
• Hobbies: Activities you enjoy, such as sports, music, dance or any other thing you want to learn.
• Subscription services: From your daily newspaper to Netflix, all the subscription and media services, gym memberships and other repeat subscriptions.

20% for Savings and Debt Repayment:

This category focuses on building your financial security by saving for the future and paying down debt. It is crucial for long-term financial goals.

• Fund for emergencies: Saving for unforeseen expenses such as medical emergencies.
• Saving for post-retirement life: Saving in pension plans and other retirement plans.
• Saving for life upgrading: Saving for your dream house or the favourite car.
• Debt repayment: Clearing off high-interest debt, such as credit cards and mortgages.
• Investments for future: Investing in stocks, bonds or others for a better future.

How to use the 50/30/20 Rule:

1. Calculate your after-tax income: Assess your net income after taxes and other deductions
2. Calculate your spending limits: Multiply your after-tax income by 0.5 (50%), 0.3 (30%) and 0.2 (20%) to determine your spending limits for each category.
3. Track your spending: Monitor your expenses to ensure you’re staying within your allocated spending limits. You can use budgeting apps, spreadsheets or online tools to track your spending.
4. Adjust as Needed: The 50/30/20 rule is a guideline, not a strict rule. You can assess your plans so that you can identify the areas where you can adjust the percentages based on your financial situation. For example, if you have high interest debts to clear, you can reduce from wants and allocate more than 20% to debt repayment.

Example of 50/30/20 Rule:

Let’s say your monthly income after taxes is Rs.50,000. In accordance with the model we referred to, the 50/30/20 rule’s is the distribution of your earnings into different categories looks like this:

1. Needs (50%): 50,000 x 0.5 = 25000
2. Wants (30%): 50,000 x 0.3 = 15000
3. Savings and Debt Repayment (20%): 50,000 x 0.2 = 10000

Benefits of the 50/30/20 Rule:

• It is easy to understand and easy to implement.
• It is adaptable to different income levels and financial situations
• It promotes a balanced approach to spending, saving and debt repayment.
• It encourages you to track your spending and become more aware of where your money is going.
• It provides a framework for achieving your financial goals by prioritising saving and debt repayment.

Conclusion:

This is the simplest and most effective method for handling your money and reaching your financial objective. You may easily climb Everest out of financial management once you comprehend and use the 50/30/20 rule to your finances. This will allow you to save in those three areas. Either budgeting according to the 50/30/20 rule or using the envelope method can help create realistic yet smart spending that also can help discipline spending habits. It is highly likely to improve financial literacy and equip one with the necessary tools to handle unexpected disasters. However, there is always one critical point to always keep in mind: that you must determine how you are spending the funds and why this should be a top priority when setting a financial goal. Hence, by establishing both short-term and long-term objective will provide a clear path for budgeting which ensures the financial stability and discipline in money management.

This Article is for information purpose only. The views expressed in this Article do not necessarily constitute the views of Kotak Mahindra Bank Ltd. (“Bank”) or its employees. The Bank makes no warranty of any kind with respect to the completeness or accuracy of the material and articles contained in this Article. The information contained in this Article is sourced from empaneled external experts for the benefit of the customers and it does not constitute legal advice from the Bank. The Bank, its directors, employees and the contributors shall not be responsible or liable for any damage or loss resulting from or arising due to reliance on or use of any information contained herein.