Growing up, I was perhaps the unusual girl who loved going to schools, learning all about math, literature, history, geography, science, English, and more. Those were surely the best times of my life: stress-free and debt-free!
However, one thing that the education system failed and still fails to do is to teach us about practical life skills like money management.
I didn't know anything about money until I stepped into the real world and had to deal with real-life money decisions. I often had questions such as: How do I invest in the market? How do I save? What is a retirement plan? Why do I need a savings account?
It wasn't until I had the answers that I realized that when it comes to personal finance, it is no surprise that many of us are incapable of managing money and "magically" ending up in tons of debts. This is why today I would like to introduce you to one of the simplest and most common practical money tools known as the 50-30-20 Budgeting Rule.
The 50-30-20 rule is a straightforward money budgeting tool that consists of allocating:
50% of your after-tax income towards your needs such as a mortgage, insurance, utility bills, and basic necessities.
30% towards your wants such as dining out, entertainment, and lavish apparel.
20% towards your savings such as retirement accounts, emergency funds, investments and etc.
Now the difference between needs and wants is debatable. In the simplest form, needs are items that we cannot live without; items that are essentials for our survival whereas wants are items that we would like to have because they make our lives much more satisfying and comfortable but don't necessarily require us to live. Being able to distinguish between need and want is what will help us to achieve our financial freedom and goals.
A rule of thumb to identify whether an item is a need or a want is to ask yourself: Do I have an alternative option? For instance, would I rather have a gym membership or workout at home?
I struggle myself when it comes to differentiating between wants and needs. For instance, I can tell you for a fact that at beginning of my career, I used to spend tons of money on my fancy and useless morning coffee every day. When I think about it, I could have put that wasted money towards my retirement plans and be rich by now. Luckily, it is a lesson that I learned and a bad spending habit that I stopped.
The 50-30-20 is just a guideline and not a rule set in stone. You can deliberately modify this rule by having 45-35-20, 40-30-30, or whatever combination you like. A lot of the time, this rule will depend on several factors such as your lifestyle, stages in life, and income your earn. The goal is to start with your budgeting path.
My say about this rule is to rather allocate 30% instead of 20% of your income towards savings. With the current health and financial crisis, we are living in a situation with people being laid off or facing unexpected medical expenses. Therefore, it is always convenient to have some savings toward emergency funds. And honestly, you get so many benefits from saving up such as the POWER of COMPOUND INTEREST!
To conclude, the 50-30-20 Rule is undoubtfully one of the easiest engines to start budgeting for anyone who doesn't know where to begin with.
"The simplest definition of a budget is telling your money where to go.”
– Tsh Oxenreider