One of the best things you can do for your finances is to plan your spending ahead of time. However, budgeting can be difficult and most people struggle to stick with the habit long term. Tools such as the 50/30/20 rule help by taking some of the pressure away from budgeting, making you more disciplined with your money and getting you that much closer to your financial goals.
How does it work?
The 50/30/20 rule is a ratio you can apply to your expenses. Essentially, you apportion 50% of your earnings on needs, 30% on things that you want and the remaining 20% on savings and debt.
Say, for instance, your income after tax is Kshs 60,000. That would mean setting aside Kshs 30,000 for your must-haves, Kshs 18,000 for wants and Kshs 12,000 would go into your savings and debt repayments.
How do you decide whether a certain expense is a need or a want? To begin with, the only items in the “needs” category should be items you cannot live without, no matter what. They include housing, food, utility bills such as electricity and water, transport, and clothing. Dedicating at least half of your income to these will ensure that your essentials are always covered while still giving you room to meet other financial obligations.
But what if, after running all the numbers, your essentials cost more than 50% of your earnings? Well, it means that you are living way beyond your means and you need to adjust urgently. Maybe you are spending too much for rent or food and you need to find cheaper options. Alternatively, you can find other ways to increase your income, so that, even if your expenses remain constant, they consume less of your total earnings.
The second category – wants – belongs to those things you’d like to spend money on but whose absence will not hurt you. They include expenses like eating out, vacations, gifts, and subscriptions and memberships. It is important to be able to afford a few things that you enjoy, just as long as you do not overindulge.
Finally, the savings or debt money can be used to build emergency savings, save towards a specific goal, for instance to buy a car, and to pay off running debt, such as HELB, a credit card, etc. Managing debt is one of the most crucial steps in achieving financial freedom, so you need to ensure that at least some of your income goes towards getting you debt-free. Savings are also necessary for your financial wellbeing and you should do it regularly.
The 50/30/20 rule is a guideline to help you budget more efficiently. You may need to customize it to meet your specific needs. For example, if you find yourself consistently spending less than 50% of your income on needs, that extra amount can be reallocated elsewhere – savings, for example. You may also need to adjust for specific goals. Say, for instance, you are saving for a vacation in a few months. You may need to spend less on wants for that duration so that the extra income goes towards the vacation. Lastly, the rule should not be used in isolation. Apply other best practices such as investing, proper debt management and tax planning to maintain your financial wellbeing.