The 50/30/20 rule tells us that we need to allocate 50 per cent of income to needs and 30% to wants and save 20%.
50% to Needs
30% to Wants
20% to Savings
This rule might be able to keep you out of debt but it will not help you to be rich or financially independent.
Also check the 50-30-20 rule based calculator.
There are few flaws with this rule.
Firstly, allocating 50% of your income is a percentage basis. That is if you are earning 100,000 dollars per year and your friend having the same lifestyle as you-is earning $50,000 per year both will allocate $50,000 and $25,000 to your needs respectively.
You will end up with too much money to spend on your needs compared to your friend.
Want vs Need
There is a fundamental difference between wants and needs, cost of fulfilling a need between two people living in the same city and having the same lifestyle should not vary that much.
A need can easily be turned into a want, for instance going to the office is a need and this can be fulfilled by using public transport or hiring a Taxi/Uber or your personal car.
Cost of fulfilling a need depends on how you fulfil it, a need should always be the minimum amount that you need to complete the need.
Anything additional should be coming from want, in our example, if you prefer to take a Taxi then your budget for transport to work will be a combination of Need and Want ($X need +$Y Want).
How much should you allocate for Needs?
So, to get to percentage allocation for need you need to calculate the $ Cost for fulfilling all your needs, remember it is the minimum value that you have to pay to fulfil the service.
Once you have $ Cost, you can derive the % allocation from your after-tax income.
“Wants” define your lifestyle, how luxuriously/comfortably you want to live. It is hard for anyone to define how much percentage of your after-tax income can your wants be.
The more you are able to push and keep your comforts to the minimum required the better it is for your financial future.
This budget framework is a starting point, like any other, it gives you a tool to taper your budget as per your after-tax income and your lifestyle.
Parkinson’s law applies to wants as well, where your mind keeps telling you to spend till the budget boundaries.
For most people, on the whole, the problem is not the income it’s controlling the expense its the wants that make or break your bank account.
So how to budget your wants?
Start with your previous month’s expense and categorize them as wants, an expense has to fall into a Need or Want Category.
Sometimes an expense can be a combination of both, as per our example before if you have travelled to work by Taxi. Then it is an expense across both a Want and a Need.
This will give you a view of (25% needs + 55% wants + 20% Savings) where your money is spent, your work to build a solid financial foundation starts here.
Start your critical thinking on your Needs and Wants. You will not be able to drastically reduce Needs as needs are the expense that is required without which you will not be functional.
But if your needs are high, there are some creative ways to make a small dent in this expense, like reducing your electricity consumption, shopping groceries in a frugal way etc.
Wants is where you will have bigger wins, this is where you can challenge an expense or postpone or find a cheaper alternative option.
When you look at all the “want expenses“ they will appear as something that is required for a comfortable life.
Remember law, where spending expands the budget allocated.
To challenge your thinking and achieve a win in the amount spent on wants, reduce the budget allocated.
For instance, from last month analysis, you are spending 55% of your after-tax income on Wants.
Reduce it to 40% and sort your wants from the expense that are giving you a comfortable lifestyle to very comfortable lifestyle.
Bring down the ones in very comfortable lifestyle to a comfortable lifestyle, this will boost your confidence and a winning streak.
If you are able to reduce your 55% want to 40% you have now boosted the amount you can save/debt repayment capacity from 20% to 35%.
Bottom line is if you follow the rule 50/30/20 as is it will not be practical and you will not be able to achieve much.
Try to understand the reason behind the framework, it is firstly, to make saving part of your after-tax income into a habit.
Strengthening the core pillar of personal finance, spend less than you earn.
And, secondly to boost your savings by knowing the flow of money out of your wallet.
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