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What is the 50-20-30 Budget Rule, How Does it Work? Research Team | Posted On Saturday, April 20,2019, 04:57 PM

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What is the 50-20-30 Budget Rule, How Does it Work?



What is the 50-20-30 Budget Rule?

The 50-20-30 rule refers to a simple way to budget your monthly income. The rule is the key to saving money effectively each month. The 50-20-30 budget rule can be a great tool for people who do not have the patience for tracking spending in detailed categories. 

The 50-20-30 budget rule requires you to track and divide your expenses into three main categories: needs, wants, and savings. This will enable you to save time and allows you to focus on the allotment of funds for each of the categories. Once you have figured out your after-tax income, you can devote the first 50% of your salary towards your necessities. The next 30% of your income should go towards your wants. The remaining salary i.e. 20% should go towards your saving.

How Does the 50-30-20 Plan Work?

This rule enables you to work on your personal finances. It is simple to understand and incorporate it in daily life. This budget rule is a good starting point for a budgeting novice. Given below is a step-by-step method of implementing the 50-20-30 rule in your budget:

Calculate your Income That Remains After Tax Deduction

Firstly, you need to calculate the amount of money that remains with you after all the deductions. Your after-tax income is what remains of your salary after paying all the taxes like professional tax, income tax, etc. If you are a salaried professional, then your after-tax income is what you receive monthly as a salary. Also,tax deductions are clearly mentioned in your payslip. But if you are a self-employed individual then your after-tax income is equal to your gross income minus your business expenses and the amount of money you pay as taxes.

Limit your Needs to 50% of Income

Here you need to understand what your actual needs are. Needs are basically those expenses or payments that impact the quality of your life. You cannot lead a life without your basic necessities like water, gas, electricity, etc.

So make sure that out of the total salary, you devote 50% to pay for the necessities like utility bills, electricity bills, rent/EMI for a home loan, personal loan, gas bills, groceries, insurance bills, medicines,and the like. Here you need to forgo some of the expenses that are not necessary like cutting down on some needless grocery items, saving on electricity bills by using power saving appliances or CFL lights,cancelling unnecessary club memberships or cutting down on using credit cards, etc. If you are overspending on stuff you don’t need, then it’s time to cut such expenses and save more.

Spend 30% of what you want

The expenses in this category are the entertainment expenses, restaurant bills, travel and, vehicle expenses which do not fall in the regular bill payments. All the expenditures in this section must be real and worth spending for. Here you need to make a choice as wants are basically those little extra expenses that make your life enjoyable and entertaining. So don’t choose your wants just to compete or show off to others. Choose the wants that really make you and your family happy. These are lifestyle expenses that vary from person to person. So while budgeting,includethese ‘wants’ according to your family needs and your income.

Spend 20% on Savings and Debt Repayments

In this category, you devote 20% of your monthly income to save money for the rainy days. Here you should spend 20% of your after-tax income for saving money in your emergency funds and retirement accounts. Build an emergency fund for medical emergencies. Also, diversify your savings by investing in low-risk investment options that will enable your money to grow over time. This saving will help you fulfil your short term and long term financial commitments and also keep you financially independent.

Explanation with the Help of an Example

Let’s say your take-home salary is 50,000 per month. Using the 50-30-20 rule, you can spend no more than Rs. 25000 on your needs per month. You probably can’t afford Rs. 20000 rent or EMI payment. So you have to accommodate your needs within Rs. 25000 budget.

The next 30% of your salary(Rs. 15000) will be extended towards your wants. Here you can cut down on some lifestyle expenses and shift some of the money to your wants section if there is a shortfall of funds in the needs section. By doing this, you can bring down your needs to a manageable level and then devote money to your wants.

The remaining 20% will go straight towards your saving plans. Now that you are left with this money, you can save for fulfilling your future goals and save money for emergencies. Saving money in investment option like FDs, PPF or LIC can help you claim tax deduction on your taxable income under section 80C of the income tax act

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