What is the 50/30/20 Budget Rule?

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Personal Finance Management is an essential skill that every Canadian should have. It involves a holistic understanding of your financial situation and taking practical steps to make the best use of your earnings. Financial planning can be quite technical, and it requires a lot of discipline as well as comprehensive knowledge of useful finance techniques.

Budgeting, Saving, Investing, Debt management are all technical aspects of each individual’s finance that must be put in order.

To have full control of your financial security, the willingness to undertake positive actions alone is not enough. You should also know the techniques that can help you attain your goals efficiently and effectively. In this article, we’ll focus on Budgeting. The 50/30/20 rule is a budgeting technique that is common among Canadians.

It is important to note that this budgeting technique can be used by individuals and corporate entities as well. It

The impact of the Covid-19 pandemic shocked us all. But not everyone was caught by surprise. When its impact hit, some people were adequately prepared because of their stellar budgeting skills. If you are struggling with your finances, chin up. With the 50 30 20 trick, you can get it together in no time.

What is the 50 30 20 Rule? 

Drawing up a budget is easy. Executing is the challenge. The 50/30/20 rule is a simple tool to organize your spending. It sets out to help you allocate your income to three broad areas of spending. It was popularized by Elizabeth Warren and her daughter, Amelia.

The rule states that you should divide your income into three unequal parts after paying your taxes. Allocating 50% to your basic needs, 30% to your wants and cravings, and the remainder 20% should go into your savings.

To really understand the essence of the 50/30/20 rule, we need to describe each of the three components.

Needs

This refers to items that you require as a human to live a dignified life or be free from harm. Examples of such things include:

  • Food
  • Rent
  • Grocery
  • Clothes
  • Utility bills
  • Transport costs
  • Child Expenses

Another item in this category that cannot be ignored is debts. If you have outstanding debts and other liabilities to settle. The minimum monthly amount that is expected of you should be included in this category. Examples are;

  • Insurance premiums,
  • Mortgage payments
  • Loan servicing
  • Credit card payments

All of these are also items that you should consider as matters of necessity.

Timely payment of your utility bills, minimum debts service, and essential expenses are items that should occupy the highest positions on your priority list. And it would be best if you allocated the highest portion of your income towards them. They ease your pressure and sets you up for a comfortable, healthy life in the future.

Wants

Wants are items that you would absolutely love to have, although your life would not be threatened if you do not have them. 30% might seem quite a lot but if you work very hard, it should reflect in your standard of living. There is a fine line between your needs and wants. Distinguishing between needs and wants is not quite easy. Some experts even say that it is a personal decision that can vary from one budget period to another.

The 50 30 20 rule stipulates that you should apportion half your income towards your basic needs in life

For instance, while a walking stick can be a fashion item for a younger person, it can be an absolutely essential item for an aged person. Similarly, a piece of eyeglasses can be deemed a fashion statement by one person, while a person that has an eye defect will consider it a necessity. As his/her quality of like may deteriorate without it.

Generally, wants are regarded as extra items that are meant to enhance our standard of living. They are items that aren’t essential to life of all people.

You should think carefully when and recognize things that you can live without. Your wants may include items like

  • Holidays
  • Shopping
  • Traveling
  • Restaurant dining
  • Gym activities
  • Hobbies  

It is observed that when people get into financial trouble, it is often due to excessive spending on wants and cravings. Human wants are insatiable. To attain financial security, you need to be disciplined to keep your indulgences in check.

The 50/30/20 rule says that only 30% of your income should be allocated to wants and cravings.

-Savings

This is the final category. Savings broadly means put money aside today for future use.

This category should include also include any debt payments that are beyond the minimum payment.

This is because when you make pre-payment on debts, it clears part of your future obligations. It can be wise to pay down on some of your liabilities early as it can help you avoid high-interest accumulations as well as improve your credit score.

Asides from your regular savings account and piggy banks, Savings also includes emergency fund contributions and retirement savings contributions. Examples of long-term savings channels in Canada include,

  • Savings accounts balances
  • Starting and growing a long-term retirement savings account. e.g Registered Retirement Savings Program (RRSP)
  • Tax Free Savings Account (TFSA)
  • High Interest Savings Accounts (HISA)
  • Paying Off Mortgage
  • Fixed Deposits
  • Bonds & Investments
  • Pre-payments on Debts

The RRSP and TFSA are prominent in Canada. The government regards them as tax sheltered accounts. In essence, you will not be taxed for the amounts of money you deposit in these accounts. The government does this to try to encourage people to save more money for their future.

The Average Retirement Age in Canada is 65. By then, it is expected that you would no longer be able to work as hard as in your earlier years. Hence, we all must lock away a portion of our earnings during our active days.

Some major Canadian banks offer healthy interests on savings, which can yield passive income for you. Look out for the rates so you can take full advantage of the opportunity to earn significant passive income.

The rule states that only 20% of your earnings should be allocated to savings.

Benefits of Implementing the 50 30 20 Rule

1- It is good for strategic planning.

2- Helps you fulfill your current obligations.

3- It helps you secure your future.

4- Improves your decision-making.

5- It helps you identify potential financial problems before they occur.

Who uses the 50 30 20 Rule?

The 50/30/20 can be practically impactful for Canadians who earn earning a regular wage or salary. Before you go out splurging, ensure you draw up your budget and appropriately allocate your income to the three areas.

If you struggle at first, ensure that your wants are the first items that you cut out. Try to lower your debts and keep seeking ways to expand your income.

Illustration of the 50 30 20 Rule 

If Brady earns $10,000 monthly and is looking to apply the 50 30 20 rule, the steps to take are as follows.

Step 1: Needs = 50% of CA $10,000 = $CA 5,000

CA$ 5,000 is to be spent on fulfilling his basic needs. 

Step 2: Wants = 30% of $CA 10,000

Brady will spend CA$ 3,000 on satisfying his wants and cravings.

Step 3: Savings = 20% of CA$2,000

Lastly, Brady gets to save CA$ 2000 in his various savings accounts.

Conclusion

Asides from the fact that the 50 30 20 rule has proven to be hugely impactful on the financial fortunes of a lot of people who have adopted it, It is worthy of note that Elizabeth Warren is an American politician and successful Lawyer who specializes in Bankruptcy law. And having made a long successful career off so many high profile cases of people who went bankrupt, she is definitely has a thing or two to tell us about how not to become one of her clients.

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Avid researcher, freelance writer, and personal finance enthusiast passionate about financial education and literacy.

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Kareena Maya

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Kareena Maya is a freelance writer focused on the personal finance and travel spaces. He frequently writes about credit cards, banking, student loans, insurance, travel rewards and more. His work has been featured in publications such as Forbes Advisor, Bankrate, Credit Karma, Finance Buzz, The Ascent and Student Loan Planner.

Kareena Maya is a freelance writer focused on the personal finance and travel spaces. He frequently writes about credit cards, banking, student loans, insurance, travel rewards and more. His work has been featured in publications such as Forbes Advisor, Bankrate, Credit Karma, Finance Buzz, The Ascent and Student Loan Planner.