What is the 50/30/20 rule for Budgeting?

“In the long run, we all are dead” — famously wrote English economist John Maynard Keynes.

While his immortal words will never be “not true”, as a race, humans will always find it difficult to not plan for the future. In fact, the ability to ration for the future and look back at the past separates us from animals.

And where there is future planning, there will always be diverse approaches. How to go about life, when to work, when to retire, how much to save, how to save, how to invest, where to invest, how to spend, where to spend, what to spend on… probably no two individuals will have the same answers to all these questions.

However, the divergence in approaches has never stopped economists from devising guidelines and principles. One such micro-economic guideline was developed by former Harvard Law professor Elizabeth Ann Warren and her daughter, Amelia Warren Tyagi. Their guideline is called the 50/30/20 budget rule.

What is the 50/30/20 budget rule?

The 50/30/20 budget rule, mentioned in Elizabeth Warren’s book All Your Worth: The Ultimate Lifetime Money Plan, is a template intended to help individuals manage their finances.

According to the 50/30/20 budget rule, individuals should spend 50% of the after-tax income on needs and obligations that they have. Another 30% should be spent on wants, and the remaining 20% should be split between savings and debt repayment.

Let’s break it down: 

• 50%: Warren’s book describes needs as the bills that one absolutely must pay and the things necessary for one’s survival. This doesn’t include any extravagance. Just the essentials — rent, ration, necessary commute, course fee, and things like that.

• 30%: Then, wants have been described as “aspirational” spending. So, if you always wanted a leather jacket from a specific brand, or wished to take a vacation at a certain place, or just wanted to buy your favorite sneakers — it could be anything, you are entitled to spend towards your wants.

• 20%: Finally, savings — the word is self-explanatory. But savings could be done in any form of your preference. Deposits, insurance, investment, and the like. In her book, Warren promises a financially fulfilling and secure life if professionals follow the 50/30/20 budget rule.

50/30/20 rule: The rationale behind

 Like every other economic theory, the rationale behind the 50/30/20 rule is to ensure that individuals navigate through obligations and needs without fiscal constraints despite a limited availability of resources( fixed inflow of funds).

Reverting to the 50/30/20 rule, the underlying principle is to make sure that individuals spend in a way that they cover all their needs, most of their demands, and still have some saved for a rainy day or old age.

Surely, if the rule is followed in letter and spirit, it has the potential to act as a cushion against economic bumps. The best part of the rule is that it accommodates for human “frailties’ ‘ — it leaves 30% of the after-tax income for individuals to spend on wants. Warren understood that continuously saving every penny without small rewards isn’t plausible for everyone.

So, the rule provisions for some money to be spent on things that people want — like a reward for their month’s hard work. Additionally, this 30% spending on wants allows for humans to climb the stairs of socio-economic hierarchy.

We are all trying to achieve a status, and those who are already there, are trying to sustain it. So, the paintings you buy with that 30% (reserved for wants) get you into the art club coterie; the tennis club membership you paid for gives you access to city’s who’s who; or the organic fruits you now buy gives you a healthy diet you always craved for. It could literally be anything — but in the end, every “avoidable” purchase you make, helps you raise your social status.

Financial Planning is all about budgeting and allocating funds prior in time to meet future goals and objectives without much strain. This confluence of financial planning in Warren’s 50/30/20 budget is probably the most fascinating. And arguably, that’s why her calculations are practical for all age groups across the world.  

50/30/20 rule: Is it for everyone?

Nothing is written in stone. At the end of the day, the 50/30/20 budget rule is just another guideline. No guideline can make sense for every individual or every circumstance. Like the Bhagavad Gita says — “everything is circumstantial. Everything is relative”.

For instance, if you’re a fresh recruit earning Rs 20,000 in New Delhi, there is no need for you to adhere to the rule in its entirety. Maybe, you have an education loan to pay back; maybe, you have a family to support; maybe, someone in your house has a medical condition that requires you to spend from your piggy bank. There could be “n” number of circumstances preventing you from following the budget rule.

But that’s okay. You can create your own iterations of the rule that suits your circumstances and needs. The key aspect is to stick to a fiscal routine and eventually align with rule — whether you come from a modest background or an affluent one. Further, the rule makes it easier for us to have a better relationship with money, keeping our expenditures and savings in check.

The 50/30/20 rule came up in 2006 when Warren’s book realised. It took about another four years for the rule to gain credence among industry leaders and professionals. Ever since, this rule has been reaching new audiences in new geographies and surprisingly, winning over everyone who’s trying to use money in the most productive way possible.

 The rule has survived nearly two decades and gone (almost) unchallenged. As per the ‘Lindy Effect,’ anything that holds true despite a long passage of time must have some inherent value—the clincher being, “In the long run, we all are dead.”

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Disclaimer – This article is for educational purposes only and does not intend to substitute expert guidance. Mutual fund investments are subject to market risks. Please read the scheme-related document carefully before investing.