Understanding the Magic of the 50/30/20 Rule
Created on 17 Feb 2021
Wraps up in 5 Min
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Updated on 18 Feb 2021
Do you struggle to save a portion of your monthly salary for your future? Have you also become a regular customer of Amazon, Zomato, Myntra, Swiggy or any other online shopping platform?
If yes, then this amazing 50/30/20 Rule can solve your financial troubles!
Quite often considered as the Rule of thumb for saving money, the 50-30-20 is actually a proven formula to help you save a considerable amount of money and secure enough for your financial future.
So, let us take a look at this golden Rule.
What is the 50/30/20 Rule?
The 50/30/20 is a widely popular savings method that emphasizes on the proper allocation of your monthly after-tax income towards different components. These components are categorized into needs, wants and savings, and 50%,30% and 20% of the monthly after-tax income is allotted to each of them, respectively.
Let's dive deeper into the different components of the 50/30/20 Rule.
Components of the Rule
The first and foremost step of applying the Golden Rule of 50/30/20 is to determine your monthly income. Your gross salary includes retirement benefits, provident fund contribution, perquisites, etc. However, one mustn't forget that the government can take away up to 30% of your salary if you haven't done proper tax planning.
So, it is necessary to consider the salary after deducting the estimated tax associated with it. Also, in most cases, the employer already deducts the tax and remits the balance salary in your bank account.
Necessities and Needs
These include essential expenses like accommodation, groceries, conveyance, internet, child education, and many more; in the absence of which it can become impossible to survive.
Also, the recent COVID-19 pandemic made us realize the importance of health too. So, life and health insurance can also be included in the necessities portion of your expenses.
But, even though the needs and necessities are essential for survival, they should not exceed 50% of your monthly income.
They are the things that do not impact your survival but are wished for by everyone. A common example can be wanting to buy a Netflix subscription.
According to the Rule, your desires and wants should not exceed 30% of your monthly income.
It is rightly said, "RICH People plan for three generations, POOR People plan for the weekends."
Saving money is the first step towards achieving financial freedom. If you cannot set aside your money, then investing it is not your cup of tea. According to this rule, you should save at least 20% of your income. We should utilize these savings to first build an emergency fund and later on, an investment portfolio, which can accumulate your wealth and make it grow exponentially.
Even the government realizes the importance of savings. That is why it has enacted the Employee Provident Funds Act, according to which, at least 12% of your salary is to be deducted mandatorily. And the employer has to contribute the same amount! Additionally, you can even earn an interest @ 8.5% on the total amount, which can be exempted from tax.
Understanding the Rule with an Example
Coming back to the Rule, let's take an example to understand it better.
Let's consider your income to be Rs 30,000 per month. Accordingly, your necessities should not exceed Rs 15,000 per month. If it exceeds so, it is advisable to forego or reduce your wants unless you can manage within 50%.
Now, your wants can be up to Rs 9,000 per month. But they can be adjusted with the needs, as mentioned before.
Lastly, after all, your necessities and important wants are taken care of, you should try to save at least 20%, i.e., Rs 6000 per month in this case.
Considering this rule, one should try not to spend the entire monthly income. Only in case of extreme emergencies should you spend all of it.
How to apply the 50/30/20 Rule?
After understanding the Rule, it is also crucial to know how you can apply it effortlessly. Merely knowing about it theoretically won't solve your financial troubles. So, the following steps can be adapted to actually implement this Rule in real life:
Maintaining an Expense Budget
"A budget is telling your money where to go, instead of wondering where it went."
One of the most effective ways to save money is to make a budget about income and expenses. The expenses should be categorized into needs and wants and recorded and analyzed. If you don't have the time to do so, then an expense-tracking app like ExpenseBit can be your guide.
Creating an Investment Portfolio
Merely saving will not help in achieving financial freedom. The rampant inflation will gradually decrease its value and make your efforts go vain. Therefore, it is necessary to create a proper investment portfolio to beat inflation and make money even while you're asleep.
The best investment to get high returns is through the stock market. However, if you don't know about it, you can invest in Mutual Funds also. The returns earned from them will be much higher than depositing into Bank FDs and will push you towards your goal of having financial freedom and security.
Earning Passive Income
The base of the 50/30/20 Rule is your monthly income. Why sacrifice your wants when you can increase your earnings? Passive income is the way to earn money, even when you are not working. Here are some fascinating ideas to get rid of the income constraints:
Invest in Real Estate: Besides getting capital appreciation, you can also earn monthly rent. Even if you take a property on loan, it will supplement your income in the long run, aside from being a good investment.
Content Development: Today's era is the era of content. If you have the passion and the skills to develop content, you can monetize it to increase your income. For example, teachers can sell online courses on websites like Udemy and Coursera, pro-gamers can open a YouTube channel and earn money by Google AdSense.
Affiliate Marketing: If you have enough reach as an influencer, you can earn money by promoting the products through affiliate marketing. For example, travel vloggers can also put advertisements on their vehicles besides getting ad revenue.
The 50/30/20 Rule helps you allocate your income appropriately. It also focuses on securing a healthy financial future by making you save at least 20% of your income. While calculating the monthly income on which the Rule would be applied, one should also consider taxes as they can significantly reduce the income.
To apply the Rule, you should maintain a budget of your monthly income and expenses and analyze it. Besides saving money, you should also focus on investing your savings to earn inflation-beating returns. You can also earn passive income.
All in all, one must remember that "If you don't stop buying things you don't need, then you soon will be selling the things you need."
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