The 50-30-20 rule of financial planning

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Bombay: When you have a steady income, it’s also important to have a structured flow of expenses. Expenses can be classified into three categories:

  • Necessary expenses that cannot be stopped
  • Wants – expenses that give satisfaction/happiness but are not necessary
  • Savings – a fixed allocation of your income that needs to be saved for a rainy day

Nowadays, basic necessities are becoming more and more expensive. With needs taking away most of your income, how do you make sure you have enough money left to allocate to wants and savings?

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To answer this question, we were joined by Kaustabh Belapurkar, Director of Fund Research, Morningstar Investment Advisers India on ET Money Show.

He pointed out an important rule of thumb that one should follow when budgeting for expenses, which is the 50-30-20 rule of financial planning.

What is this rule?

This basic budget rule allocates a different percentage of your after-tax income to the three expense categories. The rule says that one must allocate 50% of one’s income to essentials or needs. These essentials could include expenses such as monthly rent, cleaning fees, groceries, insurance premiums, EMI payments, and children’s school fees.

30% of your income must be reserved for needs. These desires could include recreational activities, a family outing, picking up a hobby, dining out, etc. Although these events are fun to experience, they are not necessary to nature and, if necessary, can be compromised.

Finally, 20% of your income must be used for savings. These savings could include any investment of your choice depending on your risk appetite.

When you have a fixed allocation that you know how to allocate to different categories of expenses, it becomes easier for you to create a budget each month, and stick to it. As income increases, one can change the allocation of funds to the three categories, basically on the back of these guidelines.

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