Budgeting and tracking once expense is one necessary activity that everyone must follow as a good habit. But not everyone follow this habit to its core. Why?
There can be several possible reason for this miss. Out of all possible reasons, one big problem is related to budgeting itself.
When we create a non-realistic budget, it often leads to non-compliance in future.
The 50 30 20 rule helps people to build realistic monthly budget for themselves.
Initially, when I heard about this rule it look very simplistic.
But over the period of time, after using and implementing this rule, I have found that this is one of the best personal finance principal that we can apply to our daily life.
How does the 50 30 20 rule helps in creating a fool proof monthly budget?
I am not sure if this rule helps in creating a fool proof budget or not, but it surely helps in building a very realistic budget.
What I mean by realistic budget?
If the budget is too strict, it will be hard to bring it to practice. As a result, people end up not following the monthly budget altogether.
If the budget is too lenient, it will be too easy to follow but it will not give you the desired end results.
What are the desired end results?
The best monthly budget should be a balanced one.
A budget which helps you in payment of all your monthly bills, paying-off your debts, and also gives you some free cash so that you can be entertained, can be tagged as a best budget.
The 50 30 20 rule helps in creating the best balanced monthly budget.
In todays society where extravagant spending’s are becoming a part of life, having an easy-tool which will guide us to “live within our means” is of paramount importance.
The 50 30 20 rule is that easy tool that helps us to build an exemplary monthly budgets for self.
Understanding of 50 30 20 Rule
Before we start building our monthly budget using 50 30 20 rule we must first understand clearly the concept of this rule.
To do this, we will imagine our total income as big size family pizza.
Now, this pizza needs to be bifurcated into three parts as mentioned below:
50% – for Must-Haves
30% – for Wants
20% – for Financial Health
So, what does these bifurcations mean?
50% off the total income will be spent to manage the must-haves. Examples: paying for essential (food, clothing, and shelter) like utility bills (including phone bills), grocery/vegetables, fees, clothes, rent, EMI etc.
30% off the total income will be spent to manage the wants. Examples: paying for self-infused essentials (to maintain standard of living) like gym, Digital Television/Netflix, movies, dinning out, extra mobile phone bill, miscellaneous shopping etc.
20% off the total income will be spent to manage the financial health. Examples: Savings, loan prepayments, and investment.
Build Monthly Budget using 50 30 20 Rule
Now we exactly know how to distribute our monthly income as per 50 30 20 rule.
That is all with the basics. No we will use the 50 30 20 rule to build our monthly budget.
In order to build an exemplary monthly budget, it will be important answer four important questions.
#1.Q – What is my total monthly income?
#2.Q – What are my Must-Haves?
#3.Q – What are my Wants?
#4.Q – Am I saving, investing and paying my loans fast enough?
#1. What is my total monthly income?
Here, the total monthly income is not the gross income (CTC). This is that income which gets credited to your savings/salary account every month.
For salaried people, the income that gets credited to their salary account is net of taxes and net of contribution towards their retirement savings.
[This retirement savings is actually a portion of our 20% – Financial Health]
For self-employed people, the total income will be there all earnings, minus their tax liability.
In case the spouse is also a earning member of the family, include that income as well as a part of your total monthly income.
Once you are done with this exercise, your monthly income table should look like this:
#2. What are my Must-Haves?
Must-haves are those expenses which are linked with your basic necessities of life (food, clothing and shelter).
Basic necessities are those requirements of life which if not met seriously affects the well-being of the family.
To identify ones must-haves, it is essential to 1st list down all expenses for the family.
Once this comprehensive list of expenses is ready, start tagging specific expense line items as Must-Haves
Check – After the tagging is done, make a sum-total of all Must-Have’s. The total spending on all must-haves should be less than 50% of your total monthly income.
After you are done with this exercise, your Must-Haves table should look like this:
#3. What are my Wants?
Wants are those expenses which are linked with our standard of living.
Generally we commit to these expenses to induce some comfort, entertainment and fun into our lives.
To identify ones wants, it is essential to first list down all expenses for the family.
Once this comprehensive list of expenses is ready, separate out all Must-Haves from the list.
For the remaining listed expenses, start tagging them as “wants”.
Check – After the tagging is done, make a sum-total of all Wants. The total spending on all Wants should be less than 30% of your total monthly income.
After you are done with this exercise, your Wants table should look like this:
#4. Am I saving, investing and pre-paying my loans fast enough?
We all know that it is essential to manage ones Must-Haves to survive in life.
It is also important to balance our Wants to lead a reasonably happy and satisfying life.
But It is equally important to take right steps “today”, to ensure that our “future” is also equally good or even better.
How to do this?
Save more money first. Then, invest it in right options, and finally lead a loan-free life.
This is the reason why, while preparing a monthly budget, it is also important to list down the requirement of savings, investment, and loan prepayment along with all other expenses.
Please note that these line items may look like discomforting expenses today, but in future it works like a life-saver.
Check – Make sure that you are allocating a minimum of 20% of your income to meet the future requirements of life. Allocate more fund here, and achieve a stronger financial health.
After you are done with this exercise, your Financial health table should look like this:
Go ahead and prepare your own excel sheet and start budgeting and tracking your expenses from today.
It will not take you more than half a day to build your own budget.
Use the 50 30 20 rule to make your budget more effective.
I have personally used the 50 30 20 rule to great use since last several years.
For a newbie, this simple rule will give a lot of clarity about what are essential expenses. Most of us spend as if every thing is necessary.
But classifying our expenses as “Must-Have”s and “Wants” clearly differentiates the essentials from needless spending.
No matter how frugal we are in our spending, but at the end of the day if we are not saving and investing enough, it is a big loss.
This rules also clarifies whether we are saving enough or not.
This is a must have rule that must be at the back of our mind, always.