Budget Rule

Ever heard of the 50/30/20 rule?

It’s actually an idea proposed by Massachusetts senator Elizabeth Warren. In her book “All Your Worth: The Ultimate Lifetime Money Plan,” which she co-authored with her daughter Amelia Warren Tyagi, she put forth an excellent proposal to better organize monthly budget.

What is it?

Here’s a synopsis of the 50/30/20 budget rule. Half of your monthly earning should be used to meet your needs. By “needs” Warren meant basic needs such as grocery, utility bill, mortgage, health insurance and auto insurance premium.

These, according to Warren, are at the top of monthly needs. Once needs are met, 60% of the other half of your monthly earning i.e. 30% of your total monthly income should go to fulfil all the “wants.” The “wants” include going to shop, dining out with friends or going to watch a movie on theater. Rest 20% of the monthly earning is to be saved. This is the 50/30/20 rule in a nutshell.

A rule of thumb?

The idea was proposed in 2005, 14 years ago. Since then, it’s been picked up by various people and they all appreciated it. People who follow the 50/30/20 budget rule consider it a rule of thumb. Time and again, the rule’s effectiveness has been proven. Of course, not all households are same, nor are the people running the houses. A single guy in his 30s may not be fond of saving, and for justified reasons. Hence, there must be leeways for them. The rule applies mostly to people with families and help them streamline their monthly budget.

How to apply it

Here are some important tips you need to apply the rule. These tips include lifestyle changes as well as understanding tax deduction and medicare better. Here they come.

50/30/20 and taxation

A question a lot of people ask is whether the 50/30/20 rule applies to gross monthly earning to the money that remains after tax-deduction. In my opinion, your employment status is an important variable here. If you are working full-time in an organization, your monthly paycheck is subject to a plethora of deductions including tax deduction. Other deductions are 401(K), retirement contribution or IRA, etc. If you are a part of the gig economy (basically a fancy way to describe the self-employed lot), there are no deductions of the after-tax income.

Self-employed people, however, have no reason to rejoice and people working in companies have no reason to feel disappointed. Self-employment tax not only exists, but it is almost double if you compare it to social security tax and medicare that employed people pay.

Understand your needs

At times, there’s crossover between “needs” and “wants.” That’s because people either don’t understand their need or they cannot limit their “wants” to a number of things. What exactly qualifies as a “need”? A need is something without which it’s difficult to spend life. Grocery, for example, is a daily need. Utility bills, car insurance payment, etc are also needs. If you don’t pay these bills, there will be no electricity and your car will be taken away. Credit card bills are also needs.

Method of distribution

After shortlisting your needs, you need to decide how you will distribute 50% of your monthly earning to satisfy the needs. It should be decided based on urgency and priority. If some bill or payment is urgent, it requires the lion share of the aforesaid 50%. For example, if your credit card bill is long overdue, you should pay it at the earliest.

A word of advice. Needs are the most basic ones. Do not confuse them with wants, which takes us to the next point.

Limit your “wants”

Remember, desires are always indulgent. Hence, the shorter the list of wants, the better. As mentioned already, “wants” involve dining out, going to a vacation, treating yourself with some culinary delicacies or with a bottle of wine, or buying a new brand of shoe. None of these things are necessary, yet people spend hundreds of thousands of dollars for them.

Don’t spend more than 30% of your tax-deducted monthly income on them. It might be difficult at the start to resist the temptation to overspend for purchasing a new dress, but make it a habit and with time you’ll learn to live with this habit.

Saving comes last

This is where you might disagree with Warren. You might argue that saving for the future is the top priority. The economy never fully picked up pace post-recession and experts agree that there’s a cloud of uncertainty over the economic sky. So prepping for the future is more important than everything else, right?

Well, future is not preordained. If you are too focused on the future, you’ll never learn to enjoy the present. Living at the moment is an art and it takes time to achieve mastery over it. When Warren advised us to save 20% of the monthly income, she actually insisted us to enjoy our present.

Summing up

Thousands of people from across the country purchased Warren’s book and many of them have been putting the 50/30/20 budget rule to practice. Are they benefiting from it? Yes, many of them are. What do you think? Would you follow the simple rule?