Looking to save money but have no idea how to begin? The easiest rule you can follow is the 50-30-20 rule. It helps you divide your money into needs, wants and savings.
The rule is simple, easy to understand, and is highly intuitive. Plus, it can be applied to almost all scales of financial income. Many people have found an easy way out to reach their dreams by following this simple money allotment rule.
Prerequisite – The law applies to your after-tax income (or in other words, the in-hand income)
The Needs – 50%
Needs are bills and expenditures that you absolutely cannot avoid. These include and are not limited to rents, utility bills, loan EMIs, grocery purchases, fuel, etc.
These are the must-haves and they do not include activities you do for leisure such as getting a streaming subscription or dining out.
According to the rule, half of the income that comes to your hand after deducting tax needs to be spent towards fulfilling the needs. If you are spending more than this, you need to figure out a way to cut needs.
Maybe, you can consider moving to a house with lesser rent, or perhaps saving more on electricity and water if you have been using it recklessly. If you have a car, you can use it less and take public transportation or do car-pooling.
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The Wants – 30%
Wants are the things you spend on that improve the quality of your life. But these are not essential. If you plan on going for trips or spending time for dinner on the weekend at your favorite restaurant, it comes under ‘wants’.
It is easy to cut down the ‘wants’ if you have been spending more than 1/3rd, as they are not essential for everyday functioning. Instead of going to the gym, you can work out at home.
Or you can learn basic cooking and avoid ordering food from outside. In fact, you can also avoid purchasing a TV and access all content from your computer/laptop through a streaming service.
If you are looking to upgrade something in your life, these decisions also come under ‘wants’. For example, if you are buying a bigger car instead of the current one, or choosing to move to a costlier house than your current residence. Therefore, the more wisely you can make the decisions on spending on ‘wants, the better you can save.
The Savings – 20%
1/5th or 20% of the net income must go towards your savings and investments. Whether you are adding funds into an emergency amount or paying towards your monthly SIPs, it has to be a part of this 20%.
You should always have a minimum of 3 months of your monthly in-hand salary or income, as an emergency fund. This money can be used on a rainy day if you have lost a job until you find another. Or for medical purposes, or paying towards your EMIs if your main income has come to a halt.
If you are confused about whether loan repayment is a part of savings – they are not! But if you can afford to repay some extra amount over your default EMI, you can take it out of your savings corpus. This helps you reduce the EMIs in the future or reduce the duration of repayment.
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Takeaway
No matter your scale of income, you can apply this rule to manage your wealth. You have more control over your ‘wants’ than anything else, the more you optimize this, the more you can save.
But there are ways to cut down your ‘needs’ as well, and these are typically bigger decisions like changing a house, selling off a car, etc. At the end of the day, use this rule and ensure complete control over your income and expenditures.