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The 50/30/20 rule for managing personal finances

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Updated: Dec 10, 2019, 10.56 AM IST
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Highlights


  • For overall financial wellness, the 50/30/20 is a broad guideline and will need to be supplemented by a good financial plan.
  • From the perspective of long-term financial well-being, sticking to a financial plan is important.
  • However, it is equally important to spend a decent amount of time and money with our near and dear ones to create memories for a lifetime.


By Ajit Menon

The household budget - it is one of the key challenges faced by an average Indian family. Budgeting is always a challenging task with a three way pull between necessities, luxuries or wants and investing for financial security.

Necessities would include expenses that are unavoidable for a certain standard of living like home loan equated monthly instalments (EMIs), school fees, grocery, medical insurance premiums and so on. Spending on luxuries could include optional expenses such as eating out at a newly opened fine dining restaurant and buying the latest gadgets. The big question is what portion of the income should be spent on each of these categories? Luckily, even this question has a thumb rule that can act as a guiding principle. Remember thumb rules are just that, thumb rules. It just helps you with a starting point.

Senator Elizabeth Warren popularised the '50/20/30 budget rule' (sometimes labelled '50-30-20') in her book, All Your Worth: The Ultimate Lifetime Money Plan (originally published in 2005). The thumb rule is to divide up after-tax income and allocate it to: spending 50 percent on needs; 30 percent on wants; and 20 percent to savings.

According to this thumb rule:
  • 50 percent of the earnings after tax should be used towards necessities.
  • 30 percent of the money should be spent on luxuries or wants / desires.
  • 20 percent money should be saved and invested towards your financial goals.

Prima facie, it may look rather simple but can be quite a challenging one. To begin with, how does one distinguish between necessities and luxuries or wants? There cannot be a uniform definition for necessities. Depending upon the income levels and surrounding environment, what could be classified as a necessity for one can easily be a luxury for another.

For overall financial wellness, the 50/30/20 is a broad guideline and will need to be supplemented by a good financial plan customised to the income levels and goals of an individual investor. Therefore, consult a good advisor for the same. The percentage of regular income that should be set aside for long-term investments can be debated, however what remains a universal truth is the fact that the path to achieving financial wellness starts by inverting the equation of 'Income minus expenses = savings' to 'Income minus savings = expenses'.

From the perspective of long-term financial well-being, sticking to a financial plan is important. However, it is equally important to spend a decent amount of time and money with our near and dear ones to create memories for a lifetime. As we strive to find a balance between spending to create memories and savings for a secure tomorrow, do also remember to take care of your health. Goes without saying that a good savings and investment corpus is best enjoyed when one is in the best of health. Happy Investing.

(The author is CEO, PGIM India Mutual Fund.)
(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)

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