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You have probably heard about the famous “50-30-20” budget rule. So, what is it actually? How does it really work? Most importantly, is it really a good budgeting rule for you? If not, what should you do instead when it comes to budgeting?
What Is 50-30-20 Budget Rule?
The 50-30-20 budget rule was first popularized by Senator Elizabeth Warren in her book, “All Your Worth: The Ultimate Lifetime Money Plan”.
How this rule works is that you allocate your after-tax income in a way that 50% of it spent on needs (i.e. food, utilities, rent, etc), 30% on wants (i.e entertainment, hobbies and etc), and the remaining 20% on savings, paying off debt and investment.
This rule of thumb is simple and easy to remember.
But, is it still good for you in your situation?
Why do I ask you this question?
Because everyone’s financial situation is different and everyone has different financial goals.
A one-size-fits-all budget rule might work, but it might not be the BEST for you to help you achieve your financial goals.
Is 50-30-20 Rule of Thumb Suitable For YOU?
To answer this question, you need to first understand what financial goals you have – both long term and short term.
Then, you need to determine whether or not, by following this rule, you can actually reach your financial goals.
Let’s say, your short term goal is to pay off your $6,000 worth of credit card debt as quickly as possible.
Assume that you are making $4,000 a month, by following the 50-30-20 rule, you would be spending $2,000 on all your necessities and $1,200 on your wants and the remaining $800 on paying off your debt.
From the screenshot above, you can see that you will pay off your credit card loan in 9 months if you pay back $800 every month.
Now, let’s take a look at another scenario.
What if you modify the rule by adjusting the percentage allocation from 50-30-20 to 50-10-40 to help pay off your credit card debt faster?
Now, with a monthly income of $4,000, you would be spending $2,000 on all your necessities and $400 on your wants and the remaining $1,600 on paying off your credit card debt.
From the screenshot above, you can see that, with the modified budget rule, you can pay off your credit card debt in 4 months instead of 9 months.
So, by making a small adjustment in your budget allocation, you can reduce your payoff schedule by more than half.
This same stays true for all the other types of debt such as mortgage loan and study loan.
So, if your goal is to get rid of your debt as quickly as possible, then you need to check if following the traditional 50-30-20 can really help you reach your goal.
Okay, what about other financial goals?
What if I want to save for retirement?
Or what if I want to save to buy a house?
Or what if I want to save for my child’s education?
Okay okay, I get it.
You want know if this 50-30-20 rule is still good to help you save money.
To achieve your savings goal, you must be more SPECIFIC on how much you need to save.
For example, you want to save for down payment for a house.
How much is the down payment for the house you want to buy?
If you have a good credit score and meet certain income criteria, your down payment can be as low as 3%.
So, let’s say the house you want to buy is about $250,000.
If the down payment is 3%, then you have to save at least $7,500.
Next, you want to ask yourself, “When do I want to have this $7,500 saved by?”
In 6 months or 12 months?
Let’s say you want to have this down payment in 12 months.
What that means is that you have to save at least $625 (i.e. $7,500/12) every single month for 12 months.
With a specific monthly savings goal, it makes your budgeting easier and also more effective.
Now, let’s go back to our original example.
Assuming that you are making $4,000 a month, by following the 50-30-20 rule, you would spend $2,000 on needs and $1,200 on wants and the remaining $800 on savings.
Putting $800 a month in your savings account can easily help you reach your goal of saving for the 3% down payment in less than 12 months.
So, you can see that the 50-30-20 rule works for you if you ONLY have this one goal.
Now, what if your real life financial situation is a bit more complext than this?
Let’s say you have credit card debt that you want to pay off and also want to save for the down payment for your first house.
Does it still make sense to follow the 50-30-20 rule?
To answer this question, you must again look at the specific numbers which, in this case, are your ideal monthly loan repayment and your monthly savings.
Let’s use the same example above.
Credit card debt: $6,000
Your Goal: Pay off the debt in 12 months
Down payment for house: $7,500
Your Goal: Save this amount in 12 months
To reach your goal, you would need to put aside at least $625 every month for your down payment fund and also make a repayment of $570 every month to clear your debt in 12 months.
So, in total, you have to put aside $1,195 (i.e. $625 + $570) every month for 12 months if you want to reach this short-term goal.
With a monthly income of $4,000, you would only have $800 allocated for your financial goals if you follow the 50-30-20 rule.
So, in this case, following this 50-30-20 rule would not be a good option for you.
To have $1,195 put aside for your financial goals, you must allocate at least 30% of your income for savings and debt repayment instead of the 20% suggested by the 50-30-20 rule.
So, the point here is that, you should only see this 50-30-20 rule as a reference or a guide.
How To Adjust The 50-30-20 Rule To Best Suit Your Unique Financial Situation
Depending on your own unique financial situation, you should adjust the percentage allocation accordingly to best help you achieve your financial goals.
As you already know, there are three components in this 50-30-20 financial rule of thumb:
- Spending on Needs
- Spending on Wants
- Spending on Savings, Debt repayment & Investments
So, how do you decide what percentage of income should be allocated to each?
Let’s use my own personal budgeting as an example.
Right now, I have paid off my mortgage and I don’t have other debts ( I also have no intention to get myself into any debt in the future).
So, for my financial goals, I am focusing on investing for early retirement.
This is a long term financial goal.
For me, I am planning to build an investment portfolio that is going to generate a passive income of at least $10,000 a month in the future.
To reach that goal, I must save as much money as possible every month and put it into my investment portfolio.
So, when I create my budget, I want to maximize my percentage allocation for savings and investments.
As for my essential expenses, it’s mostly food, utilities, transportation and child-related expenses.
Budgeting for my essential expense is not too difficult because some are fixed expenses.
For example, my phone bill, insurance premiums and my son’s school fee are fixed monthly cost.
For variable essential expenses such as food and transportation, I always set a dollar amount limit on these to allow me to stick to my budget.
As for my discretionary spending, I intentionally keep it low compared to most of my friends because I prefer a minimalist lifestyle.
Now, based on my situation, my budget allocation would look something like this:
- 40% on Needs
- 15% on Wants
- 45% on Retirement Investments
Remember that everyone’s financial situation is different and we all have different financial goals.
So, what works for me might not be suitable for you.
But, the principle behind it is still the same.
You can apply the same principle to design a budget that is best for you.