What is 50-30-20 rule?

50-30-20 is a simple budgeting rule to manage personal finance, popularized by Elizabeth Warren in her book "All Your Worth: The Ultimate Lifetime Money Plan".

Let's see a basic equation before moving on to the rule.

Savings ≠ Income - Expenditure

Expenditure = Income - Savings

Both equations are same in Maths but not in Finance. It's a very bad idea to first take out the funds for expenditure rather than savings.

50-30-20 rule asks us to divide our income after tax into 3 parts and allocate 50% for our needs, 30% for our wants and 20% for savings.

The savings portion can be increased based on our financial objective. But to be successful in managing our personal finance we must clearly define our needs and wants.

Needs: Things necessary for our survival or for our day to day life.

For e.g groceries, house rent, health care, Car maintenance etc. If your needs exceed 50% of our income, you need to downsize your lifestyle or shrink your wants.

Wants: Things that are not absolutely necessary but increases your utility/pleasure/comfort like Netflix, movies, shopping, Hobbies etc.

Savings: This is the most important section, savings can now be divided into further parts like investment, emergency funds, retirement plan, debt replacement, financial goal.

What if you lose your job or you have some health issues? You should have maintained at least 3 months of your income in an emergency fund. Invest the portion of your savings in stocks, mutual funds for growth. What if you want to purchase an apartment? You need to save for it every month, isn't it?

"It's not your salary that makes you rich, it's your spending habits." - Charles A. Jaffe.