Every person aiming to achieve financial freedom makes budgeting their top priority. After all, budgeting helps you track your money and provides structure to the financial plan.
The popular rule of budgeting— the 50-30-20 rule— states that 50% of your income must be spent on needs (aka fixed expenses), 30% on wants (discretionary expenses) and 20% on savings and investment.
Although I like this rule and recommend it to young earners, it is not a one-size-fits-all rule. Rather, it is a beginner's rule to budgeting meant for when your life and finances are not so complicated.
As you progress in life, you will have more responsibilities but also, a better income, which altogether requires a new rule.
I call it the ‘50-10-20-20’ rule.
It works best when customized. Let’s go through all four aspects of it one by one.
The original rule states that up to 50% of your income must be spent on your needs like electricity, phone and water bill, rent, fuel, groceries etc. However, as your income grows, the percentage spent on fixed expenses also grows but not in the same proportion. For instance, on a $10,000/month salary, your fixed expenses were $5000 i.e. 50% of your income.
Now, let’s assume you got a big promotion with a salary of $15,000/month. Your fixed expenses may increase to $6000 to $7000 assuming not a major change in the lifestyle, it now accounts for 40-45% of your salary.
If you live within your means and keep your fixed expenses in check, you no longer need to spend 50% of your income on just needs. And the remainder can be utilized for something better.
Therefore, you can customize the rule and spend anywhere between 30% - 50%. The lower, the better.
2. The 10% - Wants
We all deserve to treat ourselves from time to time but to spend 30% of your salary on just wants may not be acceptable, and I’ll tell you why.
Imagine that you’re a new earner in a new city with a monthly salary of $10,000. You spent $2000 (20% of your income) on wants. Assuming you have fewer responsibilities and no debt, you may decide to spend up to 20% of your income on wants. However, it is important to spend mindfully to achieve financial freedom early as there is no end to temptations.
10 years later…
You’re working at your dream job with a gleaming salary of $30,000 per month. You’re married, have a child and also have a joint home loan with your partner.
Will you spend 30% ($9000/month) of your salary on wants? I hope not. Doing so will only increase your financial stress and can lead to even more debt. Therefore, it is always advisable to keep your wants under control even while you make more money.
Let’s say, after 10 years, you have tamed your materialistic desires and spend only $3000-$4000 on wants. The percentage has reduced from 30% to almost 10%.
3. The 20% - Debts
Since your wants now make just 10% of your income, the remaining 20% from the original rule can be used to repay all the expense-based loans (student loan, wedding loan) and asset-based loans (home loan). This way, you can repay your debt without compromising the quality of your life.
Of course, not everyone has the same amount of debt, so you can spend anywhere between0-20%to lower your liabilities. And the remaining amount (if any) can be invested.
4. The 20% - Investments
Here comes the most crucial part— saving & investments.
As per the original budgeting rule, you must dedicate 20% of your income to savings & investments.
However, if you have limited debt (lower than 20% of your salary) and limited wants (lower than 10% of your salary), you can invest 20-40% of your income. It will speed up your financial trajectory and help you achieve your goals faster.
To structure your financial goals, divide them into 3 categories:
Time span- 0-2 years
Financial Goals: Emergency funds, travel and vacation funds, home renovation, pet emergencies etc
Time span: 2-5 years
Financials Goals: Paying off student debt, down-payment of home, buying a car etc
Time span: 5- 20 years
Financial Goals: Paying off mortgage, retirement, child's education, buying more assets.
To sum up— financial freedom, to me, is like climbing a mountain. Those who focus on the remaining distance to achieve the mountain’s peak end up overwhelming themselves before starting their journey. So, the best way is to just focus on your next step, and before you know it, you’ll be at your financial peak.
