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The 50/30/20 budgeting rule
When it comes to building and maintaining wealth, budgeting is an important foundation block.
By sitting down and completing a budget, you create a snapshot overview of your personal financial statement. In doing so, you give yourself the opportunity to gain a better understanding of the movement of your money – inflows and outflows. Moreover, this information can be used to assess your existing financial situation and devise appropriate plans aimed at achieving your financial goals and objectives, such as paying down debt and saving and investing for the future.
The 50/30/20 budgeting rule
There are many subtle rules and behaviours that we live our lives by. Consequently, whether you are relatively new to the concept of budgeting, or an old hand at it, you may have heard about the 50/30/20 budgeting rule*. In a nutshell, this budgeting rule can often be a useful starting point regarding budgeting and managing your money, as it provides a rough guide to how much money should be allocated towards your needs, wants and savings. For example:
- 50% allocated towards needs, such as rent or minimum home loan repayments, transportation, groceries, minimum credit card and car/personal loan repayments, general and personal insurances, private health insurance, education, utilities, phone and internet, etc.
- 30% allocated towards wants, such as daily coffee, eating out, shopping, entertainment (e.g. subscription services, such as Netflix), hobbies, holidays, etc.
- 20% allocated towards savings, such as emergency funds, savings accounts (e.g. saving for a new car or a housing deposit), additional debt repayments, as well as investments inside and/or outside of superannuation.
Do you know what percentage you are currently allocating towards your needs, wants and savings? If yes, has this percentage remained constant or altered over time with changes in your personal circumstances, such as starting a family or receiving a pay rise?
Things to consider
Making informed decisions on how to spend your money can be difficult for a variety of reasons, such as, but not limited to your beliefs on money and your money personality. By breaking up your spending into the above basic categories (and the allocated percentages that go with them), you may find it helpful for several reasons. For example:
- These percentages aim to help create a balance between your obligatory and discretionary costs, and funds required to achieve your financial goals and objectives.
It emphasises the importance of not only consciously and proactively allocating funds to savings, but also not overextending yourself when it comes to your needs and wants (i.e. living within/below your means and stopping the cycle of living pay cheque to pay cheque).
- This last point can be especially pertinent when considering the impact that upward interest rate movements can have on your ability to continue to service debt repayments and the potential flow-on effects of this regarding other areas of your spending (i.e. the requirement to tighten the belt, so to speak).
It can force you to consider the distinction between a need and a want at a personal level, as well as introduces you to the concept of ‘upgrading’ (e.g. a decision to purchase an upgraded version of a need, such as buying a Mercedes, as opposed to a more economical Toyota).
- By understanding the distinction between the two, you can begin to assess what really matters to you and exercise financial discipline where appropriate.
Nonetheless, due to the simplicity of the budgeting rule, certain shortcomings can arise, especially when considering your own personal circumstances. For example:
For high-income earners, the 50% and 30% allocation towards needs and wants may leave the door open to excessive or unnecessary spending to the detriment of your savings. For instance, these individuals may be negating the ability to allocate additional funds towards savings, which could facilitate reaching financial goals and objectives much more quickly.
- With this in mind, ‘lifestyle creep’ (i.e. increasing your standard of living as your income goes up) needs to be appropriately managed with one foot in the present (enjoying life now) and the other in the future (making sure you can continue enjoying life when retired).
For low to middle-income earners and/or those living in an expensive area, the 50% allocation towards needs may prove difficult to adhere to. These individuals may not have the luxury of only spending half of their after-tax income on needs, such as housing and bills. Consequently, this may affect other areas, such as the 20% allocation towards savings.
- If you are struggling to fund your needs, wants and/or savings, it’s vital to openly and honestly assess your spending – and not be influenced by, or rely on, credit cards and other forms of financing to get by. This may require some difficult decisions so that moving forward your outflows are appropriately aligned with your inflows.
Please note: To a certain extent, these two points regarding high and low to middle-income earners are highlighted in the tables displayed above.
When you are first starting out, rules of thumb, like the 50/30/20 budgeting rule, can be a useful rough guide for decisions regarding budgeting and managing your money. However, as you can see by its potential shortcomings, it’s still important to seek professional advice so that your existing financial situation can be appropriately assessed and leveraged to achieve your financial goals and objectives.
Lastly, when it comes to budgeting in general, it’s important to highlight something that was previously mentioned. A budget is a snapshot overview of your personal financial statement at a given point in time and is only as accurate as the information that has been inputted into it. Consequently, a budget needs to be regularly reviewed so that:
- The information that’s used is an accurate reflection of the movement of your money, and
- You make sure that you are sticking to the budget that you have set for yourself.
Tracking your spending is a great way to facilitate this process.