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BSB 806 015
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The 50/30/20 budgeting rule

When it comes to building and maintaining wealth, budgeting is an important foundation block. A budget can help you gain a better understanding of the movement of your money – how much you have coming in, and how much is going out.

More importantly, with a good budget you can assess your current financial position, and make appropriate plans for achieving your financial goals, such as paying down debt, or saving and investing for the future.

The 50/30/20 budgeting rule

One of the most common approaches to budgeting is the 50/30/20 budgeting rule. In a nutshell, this budgeting rule can be a useful starting point towards budgeting and managing your money, as it provides a rough guide to how much money should be allocated towards your needs, wants and savings. For example:

  • 50% allocated towards needs, such as rent or minimum home loan repayments, transportation, groceries, minimum credit card and car/personal loan repayments, general and personal insurances, private health insurance, education, utilities, phone and internet, etc.
  • 30% allocated towards wants, such as daily coffee, eating out, shopping, entertainment (like Netflix or going to the movies), hobbies, holidays, etc.
  • 20% allocated towards savings, such as emergency funds, savings accounts (e.g. saving for a new car or a housing deposit), additional debt repayments, as well as investments inside and/or outside of superannuation.

Here we apply the budgeting rule to two individuals, one receiving an after-tax income of $52,000 p.a. and the other receiving an after-tax income of $104,000 p.a.

Scenario 1 - annual income $52,000

Allocation

Expenditure (rounded to the nearest dollar)

What

Weekly

Fortnightly

Monthly*

Annually

50% Needs

$500

$1,000

$2,167

$26,000

30% Wants

$300

$600

$1,300

$15,600

20% Savings

$200

$400

$867

$10,400

TOTAL

$1,000

$2,000

$4,334

$52,000

Scenario 2 - annual income $104,000

Allocation

Expenditure (rounded to the nearest dollar)

What

Weekly

Fortnightly

Monthly*

Annually

50% Needs

$1,000

$2,000

$4,333

$52,000

30% Wants

$600

$1,200

$2,600

$31,200

20% Savings

$400

$800

$1,733

$20,800

TOTAL

$2,000

$4,000

$8,667

$104,000

Please note: As there are 52 weeks in a year, not 48 (i.e. four weeks x 12 months), the monthly expenditure has been calculated by multiplying the weekly expenditure by 4.334 (52 weeks / 12 months).

This gives you an idea of how much you’ll allocate towards each category over the course of the year, creating a balance between your needs and your wants, and how much you can put towards achieving your future goals.

Things to consider

Making informed decisions on how to spend your money can be difficult, but breaking up your spending into the above basic categories may be helpful for several reasons. For example:

  1. It emphasises the importance of not only consciously and proactively allocating funds to savings, but also not overextending yourself when it comes to your needs and wants (i.e. living within/below your means and stopping the cycle of living pay cheque to pay cheque).
  2. This can be especially pertinent when considering the impact of future upward interest rate movements, can have on your ability to continue to make repayments on debts, such as your home loan, and the potential flow-on effects to other areas of your spending (i.e. the need to tighten the belt, so to speak).
  3. It can force you to consider the distinction between a need and a want at a personal level, as well as introducing you to the concept of ‘upgrading’ (e.g. a decision to purchase an upgraded version of a need, such as buying a Mercedes, as opposed to a more economical Toyota).

By understanding the distinction between the two, you can begin to assess what really matters to you and exercise financial discipline where appropriate.

As much as there is beauty in its simplicity, there can be a few shortcomings to the 50/30/20 approach, especially when considering your own personal circumstances. 

High income earners

For high-income earners, the 50% and 30% allocation towards needs and wants may leave the door open to excessive or unnecessary spending, to the detriment of your savings. For instance, tweaking those percentages and making a higher contribution to savings may help you reach your financial goals sooner.

With this in mind, ‘lifestyle creep’ (i.e. increasing your standard of living as your income goes up) needs to be appropriately managed with one foot in the present (enjoying life now) and the other in the future (making sure you can continue enjoying life when retired).

Low to middle income earners

For low to middle-income earners and/or those living in an expensive area, the 50% allocation towards needs may prove difficult to stick to. You may not have the luxury of only spending half your after-tax income on needs, such as housing and bills. Consequently, this may affect other areas, such as the 20% allocation towards savings.

If you are struggling to fund your needs, wants and/or savings, it’s vital to openly and honestly assess your spending – and not be influenced by, or rely on, credit cards and other forms of financing to get by. This may require some difficult decisions so that moving forward your outflows are appropriately aligned with your inflows.

Moving forward

When you are first starting out, rules of thumb, like the 50/30/20 budgeting rule, can be a useful rough guide for managing your money. However, if you’re thinking longer term and looking to build wealth, it may be appropriate to seek professional advice to review and leverage your existing financial situation to achieve your financial goals and objectives.

When it comes to budgeting in general, it’s important to remember that your budget is only a snapshot of your financial position at a given point in time. Consequently, your budget needs to be regularly reviewed to make sure it's an accurate reflection of your income, spending and circumstances, and to make sure that you are sticking to the budget that you have set for yourself.

We can help with setting up a budget. Contact P&N for a financial health check, or talk to P&N Financial Planning to start to build a financial plan for your future.

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