People need to have a plan to achieve long term financial goals. If you think preparing a financial plan is burdensome, you can keep it simple. A tool many are discovering to be a useful budgeting method is the 50/30/20 rule.
The rule does not require you to do detailed planning. Instead, you allocate specific percentages of your disposable income to needs, wants and savings. By sticking to the budget, you can increase the chances of reaching your financial objectives.
The proponent of the 50/30/20 is U.S. Senator Elizabeth Warren. She was already writing books about money before being elected. In 2005, she wrote “All Your Worth: The Ultimate Money Plan” where the rule was introduced. Her book became a bestseller while the rule has become a hot personal finance practice.
According to Senator Warren, the basic rule is to divide your after-tax (disposable) income and allocate your spending as follows:
- 50% for needs or necessities
- 30% for wants, luxuries or desire
- 20% for savings or debt repayments
There is a generous allocation of the budget for flexible spending like shopping, splurges, and travel perhaps. The rule, however, does not promote careless spending. It emphasises the need to save regularly and put your finances in order.
Assuming your monthly after-tax income is RM3,000 and you want to follow Warren’s method, here is how it should look. You can spend 50% or RM1,500 for your needs such as rent or mortgage, transportation, groceries, insurance, etc. Somehow, this budget pertains to your monthly fixed costs.
The 30% or RM900 is the money you can use for your discretionary or unrestricted spending such as gym membership, eating out, Netflix membership, etc. The remaining 20% or RM600 should go to savings or payment of debts. This also could include funding for your emergency fund, investing in a retirement scheme or investing your Amanah Saham (ASB) account.
While the allocation for savings is the smallest, however it is the most important item on the budget. Warren believes that saving a little is better than having zero savings. Also, if you use the money to pay off debts, you open the window of financial opportunities. However, Warren argues that not all debts steal from your future. Mortgages, car and student loans are good debts because you get something of value in return.
On the other hand, credit cards and payday loans leave you with no asset. The tendency of many is even to build a mountain of bad debts. Therefore, the risk of bankruptcy in the future increases.
Is the 50/30/20 rule the best approach to bring you overall financial wellness? Warren’s rule is only a broad guideline to simplify the budgeting process. You do not have to run after every dollar. Just maintain the allocations and not go over each one.
Some financial advisors favour the 10% savings rule, which is a saving model dating back to the 1920s. It calls for saving at least 10% of your income as a way to build sufficient retirement funds. This rule, however, might not be applicable in the present time.
Back then, people do not live past 60 years old. In 2020, life expectancy in Malaysia is 76.22 years old. With this longevity, a 10% savings every month is not enough anymore. You might outlive your retirement savings due to a more extended retirement period.
A major challenge to Malaysian families and individual income earners is preparing a budget. The 50/30/20 budget rule is simple but not necessarily the most effective. You can even change the rule and adjust the allocations to see what works best for you.
It does not matter too if you create your own rule. The success of any budget or financial plan depends on the implementation itself. But the more important aspect is to save as much, whenever possible, for a secure tomorrow.
This article is prepared by Direct Lending, an online personal lending platform with the mission to provide simple, safe and affordable financing to all hardworking adults. We help borrowers to find, apply and receive financing that most suit them. Our service is 100% free.