What is the 50 30 20 rule of money and its limitation?

‘What is the 50 30 20 rule of money in budgeting?’ is a lesson dedicated to those people who struggle financially and are confused about how much to save and how much to spend. Senator Elizabeth Warren popularized the 50 30 20 rule in her book All Your Worth: The Ultimate Lifetime Money Plan. It is a simple rule who wants to follow a disciplined financial life. Above all, it teaches you to balance your needs, wants, and savings. However, the 50 30 20 rule of money is a standard rule in personal budgeting and more general in nature. Let’s find the rule and its applicability in your life.

What is the 50 30 20 rule?

It is an important part of your personal money management. First, you have to get your post-tax income. The income you get after paying all the taxes. For example, if you come under a 20% income slab, then you have to deduct that 20% to get your post-tax return. Once, you get your post-tax income, divide it into three categories – Needs, Wants, and Savings. You can imagine it like three boxes where you have to put your money. Now, allocate 50% of your post-tax income to your needs, 30% to your wants, and 20% to your savings. That’s it.

the 50 30 20 rule
FIGURE NO – 1

‘What is the 50 30 20 rule of money in budgeting?’ is a lesson dedicated to those people who struggle financially and are confused about how much to save and how much to spend. Senator Elizabeth Warren popularized the 50 30 20 rule in her book All Your Worth: The Ultimate Lifetime Money Plan. It is a simple rule who wants to follow a disciplined financial life. Above all, it teaches you to balance your needs, wants, and savings. However, the 50 30 20 rule of money is a standard rule in personal budgeting and more general in nature. Let’s find the rule and its applicability in your life.

What is the 50 30 20 rule?

It is an integral part of your money management. First, you have to get your post-tax income. The income you get after paying all the taxes. For example, if you come under a 20% income slab, you have to deduct that 20% to get your post-tax return. Once you get your post-tax income, divide it into three categories – Needs, Wants, and Savings. You can imagine it like three boxes where you have to put your money. Now, allocate 50% of your post-tax income to your needs, 30% to your wants, and 20% to your savings. That’s it.

The difference between needs and wants

Let’s talk about the difference between needs and wants. Needs are the things that you cannot avoid. You have to spend it compulsorily like food, utilities, transport, fuel, education, etc. At the same time, wants are the things that you do to satisfy your senses. You can avoid them, but life looks dull without them. It includes eating at restaurants, traveling, attending parties, buying expensive clothes, branded watches, etc. The list goes on. Life feels good.

The limitations of 50 30 20 rule

The 50 30 20 rule of money indeed is one of the easiest and most straightforward ways to manage your money. However, it has a few limitations that we must understand so that we can modify it according to our requirements and use it.

IT IS MORE GENERAL IN NATURE

The rule is more general than being specific. There are more than 7.8 billion people in the world. Their age, lifestyle, income, financial conditions, responsibilities, needs, wants, cultural and social requirements are different. Then how can we set the rule for all?

For example, the wants of an unmarried salaried person are different from a responsible father in his late 50’s. The younger one would like to travel a lot, eat at restaurants, hang out with his friends, watch a movie in a multiplex every weekend, and so. The older one has to spend on utility bills, tuition fees, food, ration, transport, health, and so on. Therefore, contributing 30% of his post-tax income to his wants is a total non-sense. He has to spend a lot on his needs and savings. On the other hand, the needs are limited for the younger ones, and wants are unlimited. Therefore, he may like to spend 50% of his post-tax income on desires.

Take the case of a retired person. He has saved a lot and now has reached the dusk of his life. He does not go to an office, travels a lot, watches movies in a multiplex, or has to pay the tuition fee for his children. His expenses may include doctor fees, medicines, occasional outings, and gifts to his grandchildren. He would like to spend more than 60% of his post-tax income on his justified wants.

Therefore, you have to set your own rule, which means allocate a certain percentage according to your requirements. Remember that your savings must not go below 20% in any condition, even during your retirement phase.

20% SAVINGS INCLUDE DEBT REPAYMENT

The 50 30 20 rule says to save 20% of your net income. However, this 20% allocation includes debt repayment. Thus, it reduces the actual savings allocation. You might have encountered a few people whose more than 50% net income goes towards loan repayment. Even if 20% of their net income goes towards debt repayment, the savings part becomes zero. But, he allows himself to spend on his wants as a rule says that. That’s the problem. There is no logic to pay 30% of your income on desires and 20% on debt repayment with zero savings. You have to give importance to clear all your debts first.

NO PROVISION FOR INVESTING

Saving is setting aside money from your income, but investing is to put that money in bonds, mutual funds, stocks, real estate, etc. to work for you. Therefore, you should not only focus on saving your money but put it in different investment options to beat the inflation. However, the 50 30 20 rule does not say anything about the investment part. I never mean that you should not save money, but you should not stop there. That is my opinion. Once you have enough money to meet your emergencies, your focus should shift towards investing. Your emergency fund corpus can be your six months net income or twelve months. That depends on your income stability, age, responsibilities, and a few other factors. Thus, once you decide to follow the 50 30 20 rule, make an emergency corpus, and start investing.

ALLOCATION FOR WANTS IS 30%

It is always hard to distinguish between needs and wants. For example, what is a need for someone may be a want for others, e.g., driving a car to the workplace may be a need for a businessman, but its a desire for a low-paid employee. Thus, giving 30% allocation of your net income to fulfill your wants seems illogical at some point.

Let’s take another example. A debt-ridden person allocates 20% of his income towards savings and debt payment, whereas 30% to fulfill his wants causes a complete mess. Thus, you have to modify your needs and wants allocation according to your financial situation.

ALLOCATION FOR NEEDS IS 50%

The 50 30 20 rule says to allocate 50% of your net income to needs. You can say that most of the cases fit this. However, there are cases where it does not. For example, people with a meager income level may exhaust up to 70-80% of his net income to meet his needs only. He cannot think about his wants and savings. Thus, the logic of allocating 50% to needs may not materialize in this case. Similarly, a young salaried person with a decent income and no responsibility may not require to allocate 50% of his post-tax income towards needs. He may require to allocate 50% towards fulfilling his wants or saving.

THE 50 30 20 RULE ENCOURAGES TO SPEND MORE WITH MORE INCOME

Your income increases with time. It does not matter whether you are working in the government sector, private sector, or self-employed. You should increase your saving with your increments. However, the 50 30 20 rule says growing your needs and wants with your increase in the salary. You can justify an increase in the requirements on the ground of inflation. However, an increase in your wants seems illogical to me. He could allocate more towards his savings but did not as he was following the 50 30 20 rule.

Bottom Line

The 50 30 20 rule is a thumb rule for people who cannot take a little more time to curate their budgeting. It’s easy, simple, effective, and needs no brain. It is like a ready-made dress that nearly fits a lot of people. However, it comes with tons of limitations.

For your kind information, the power of compounding works the best when it complies with time—the more time you give to your investment, the better. Thus, to maximize the benefits of it, you must invest at a very early age. However, the 50 30 20 rule says to allocate a higher percentage of your net income to wants than saving.

If you are serious about getting financial freedom at an early stage of life and get out of the Rat Race, then just following the 50 30 20 rule is not enough. You have to save a lot of money in your initial stage to retire happily in your 40’s.

I will appreciate your views, comments, and suggestions.

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