You may be wondering what the 50/30/20 rule is.
Imagine a pie…
But before we get into the ‘meat and potato’ of the pie itself, it’s worth pointing out that the idea of this breakdown is to provide input that will lead to understanding about budgeting and where your money is going – and we can do that by using a typical example of what would be an ‘ideal’ personal portfolio.
Now back to the pie…
50% of the pie is set aside for our essentials, bills, mortgage, food etc. With half of our pie left, 30% is eaten up by our ‘personal’ spending, such as the things we don’t need but want. The remaining 20% represents our goals. This is typically the amount we should be saving, while keeping in mind that we are working with an ‘after tax’ net income.
In terms of the 50% (our needs) and how to determine what that would be – these are basically something that would greatly inconvenience you… or you literally cannot live without, such as food and shelter.
The next logical area to look at would be the 30% piece of the pie which is our ‘personal spending’ i.e. the things you don’t need but ‘want.’ This is where most of us tend to blur the line between wants and needs. Some even deny the existence of the line. But it’s there!
The ‘wants’ are something that cause a minor inconvenience in your life. It’s not like needs where if you don’t eat, you’ll die – it’s more along the lines of… if I don’t get a brand-new pair of shoes, am I going to die? According to some women the answer is yes. But that’s not even remotely true is, it ladies. Simple things like cooking at home rather than eating out can dramatically change this area too. Hobbies are another. Everyone should absolutely have a hobby. Oftentimes they can turn out to be one of the greatest joys of our life.
Whatever it is that keeps you happy – do it. But don’t forget – it still falls under the ‘wants’ category. A want is not a need, but it does improve the quality of your life greatly. So, swapping the helicopter lessons for learning to fly a remote-controlled drone will keep your feet firmly on the ground and your finances in check at the same time. You get the picture!
I know a lot of this sounds really basic, but until you understand where all of your money is going, your pie is going to be a 50/50 straight down the middle and it’s going to take some real harsh lessons and a few hard knocks to get you back on track.
Now let’s go to the final piece of the pie – the 20% of your net income where your financial goals, savings and paying off debt, resides.
Let’s say you already have an emergency fund in place – this you would consider as savings. In actuality, that fund should equate to 6-12 months living expenses. For example, if your needs category and your wants category come out at a tidy 2k a month, you will need to save 12-24k in your emergency fund alone. That sounds like a lot of money doesn’t it – and it is. But one or two job losses in a family of one or two-income earners… that fund can really save your derrière. Serious ‘what if’ questions and their relevant scenarios will spur you into action on this one if you haven’t started an emergency fund already.
In addition, paying off bad debts such as credit cards and loans will be done so by using the 20% portion of your income. Then we have saving for retirement, which is a huge area that many ignore. And you don’t just save for retirement, you invest for retirement. Just saving isn’t going to be enough to reach your retirement goals. Investing will help grow your money over an extended period of time.
For example- If you invested £1,000 in stocks in 1975, by the end of 2018, your investment would have been worth a little over £130,000. How? Compound interest – which basically means earning interest on interest over time. Compound interest can help investors experience exponential growth – or growth that occurs at an increasingly rapid rate.
Now you can see why just skipping your morning take-away coffee will not make you a millionaire, not today, not tomorrow… not ever, no matter how many trending ‘influencers’ out there say that it can. It’s not realistic. Especially if you are using a credit card with an interest rate of 18% to purchase it with. Yes – people actually do that.
Financial discipline provides extra fuel for potential growth.
It’s time to say no to the extra slice of pie when we are already full to bursting. It’s time to wake up and smell the coffee (brewed at home). And it is absolutely time for us all to get serious about our money – but more importantly… what we are doing with it.