When it comes to budgeting, how much should you allocate to each area? A simple rule of thumb which is easy to implement is the 50/30/20 rule. It is a rule coined by Harvard Bankruptcy expert Elizabeth Warren. This rule offers a big picture view of what your budget should look like before getting into the nitty gritty.
So what does 50/30/20 stand for?
- 50% = Essential Expenses
- 30% = Lifestyle Expenses
- 20% = Financial Goals and Savings
Spend at Most 50% of Your Income on Essential Expenses
What do essential expenses include? They include household expenses i.e. groceries, utilities etc., transportation, personal and dependent expenses such as childcare, child education etc. It also includes home loan repayment if you own your house and stay in it. While these are expenses which are very critical to your family, they should not take up more than 50% of your income.
While a lot of the essential expenses are fixed like housing loan repayment, childcare, choices can still be made to reduce them if you happen to spend more than 50% on essential expenses. For example, one could choose to take cheaper forms of public transportation more frequently and control aircon usage at home to save on utilities.
Do Not Spend More Than 30% of Your Income On Lifestyle Expenses
Lifestyle expenses include expenses such as traveling, entertainment, dining out, luxury items etc. They are expenses which are non-essential and the guideline is not to spend more than 30% of your income on them. Since lifestyle expenses are usually a matter of choice, it is easier to scale back on them as compared to essential expenses.
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Devote At Least 20% of Your Income to Savings and Financial Goals
Saving funds and financial goals do not get achieved overnight. They are accumulated slowly over time through saving a portion of your income and then investing into appropriate investments. The 50/30/20 rule advocates at least 20% of the income goes toward savings and the higher the better.
The 50/30/20 rule provides a very simple but effective way to balance your budget. By following it, your income and expenses level should be relatively healthy. While they are not hard and fast figures, it is important not to deviate too far away from the guideline, especially if you are under-saving.