What Is The 50/30/20 Rule in Investment?6 min
Your monthly income decides how much you will accumulate or save. US senator Elizabeth Warren gave the 50/30/20 rule in her book “All Your Worth: The Ultimate Lifetime Money Plan.” This rule gained instant popularity among everyday folks as it helped them better manage their finances.
What Is A 50/30/20 Rule in Simple Language?
“I am a salaried professional with a big family. Being a sole earner this month, I ran out of cash in just the second week of the month. God knows how much debt I will take to spend the rest of the two weeks,” said a baffled Olivia Simpson, a resident of the Greater Toronto Area.
Olivia is not alone, and there are simply innumerable examples of such inefficient money management. A non-diligent and ignorant approach toward money management leads to an inappropriate budget allocation that makes you run out of cash.
It created the need for a specialized technique using which you can better manage your finances and allocate them in an appropriate orderly fashion.
A 50/30/20 rule is an optimal budget allocation plan that allows you to divide your after-tax monthly income in a pre-designated manner. A regular income stream is always good to have, and it is always essential to allocate and plan its usage.
This rule lets you use your money smartly and requires you to divide your monthly income into three distinct categories which are:
Category I – 50%: Needs That Are Necessary for Survival
This portion represents all your needs and requirements necessary to survive, and you cannot stop it. Some common examples of such expenses are:
- Tuition fees for your kids
- Charges to be incurred on grocery items
- Your daily commutation expenses
- Monthly Mortgage Payments
- Equated Monthly Installments (EMIs) for all your other debts, etc.
You cannot simply avoid these expenses as these need to be met. However, you can certainly change your lifestyle and use substitutes and alternatives to reduce your total financial outgo.
- You might prefer to instruct your kids in a less expensive school
- Shift your mortgage debt to a lender offering a lesser mortgage rate
- Cook more often in the house and reduce dining
- Reduce the usage of personal cars and use carpooling or public transport facilities more often
- Use cheaper alternatives for your current products, etc.
While deciding on your mandatory expenses, you must not get confused with all the unnecessary charges for your survival, and you can avoid them. For example, dining out, hangouts in remote locations, watching movies in theatres, etc.
As per the 50/30/20 rule, you must allocate 50% of your total monthly income towards such expenses. It is an optimal percentage, and ideally, you must be able to meet or cover all your needs and needs within half of your monthly income.
However, if you cannot do so, this rule requires you to re-plan to cut down your mandatory expenditure.
Category II – 30%: Non-essential needs, Wants, & Entertainment.
Stress is a prevalent mess that has stung everyone like a venomous snake. Entertainment, fun, and rejuvenation are some of the best techniques which help you reduce your stress levels and lead a happy life.
This rule recognizes this and allows you to allocate 30% of your total monthly income towards all your entertainment needs. So, everything prohibited in the first category becomes available in this second category.
You can spend 30% of your income to buy “wants” through your money, such as going to a movie, a trip to Caribbean islands, seasonal shopping, personal grooming, etc.
However, exercise caution as wants are simply endless, and the resultant satisfaction might urge you to get carried away. For better money management and allocation, you must try to never spend over 30% on what you want.
Category III–20%: Savings, Investments, and Accumulations
Save money, and someday money will surely save you. You can “Save money” as a habit that helps you secure your future financially. Saving money regularly from your monthly income helps you accumulate a handsome corpus that comes in handy during your testing times.
It is the last category of this rule and holds the meagerest percentage. You must save 20% of your total monthly income and invest in various investments based on your risk appetite and portfolio re-balancing strategies.
Regular and consistent additions to the invested accumulated surplus help you create a pool of money to face crises and emergencies. Further, you can also plan to save for your retirement by adding 20% of your income to your portfolio.
What Is the Conflict Between the “Wants” (Category II) And “Savings” (Category III) of the 50/30/20 Rule?
Treat “Savings” and “Wants” like “cats” and “dogs” in those stories where each of them tries to get a bigger pie.
We are not Buddhas and certainly get overwhelmed by the satisfaction gained after getting involved in a pleasurable activity.
“I once went to a movie. The other day, I went again. I will go to the movies or go on a hiking trip. I cannot avoid entertainment as it is an integral part of my life. Every day after the office, I cannot curb my urge to go out and have fun.
Such a lifestyle is hurting my finances, and I am simply juggling between my Wants and Savings. Often, I do not have any money to save at the end of the month,” said Lucas Johnson, a resident of the Greater Toronto Area.
There are so many like Lucas who face the same problem. This reason, people usually feel a conflict between their Wants and Savings.
For the successful implementation of this rule, it is necessary that you:
- Try controlling your urges, which make you crave entertainment. In case it is necessary, reach out to an expert psychologist.
- Stick to the 30/20 limit and never overspend on entertainment. If you feel you are a spendthrift, try to save a few pennies every day and put them in a box. It will develop the discipline which you are lacking.
- You can always create a leisure fund out of your total monthly income to service your bizarre entertainment needs.
Money management is an art, and to be successful in life, you must learn it. Let us know how you feel about the 50/30/20 rule.