#1 The 50/30/20 rule

One of the most basic rules of personal finance stems from the 50/30/20 rule. In extremely simple terms, the rule states that your in-hand (after-tax) income should be divided into three key areas:

1. 50% for your needs (think rent, electricity, groceries, loan repayments, etc.) — and to whoever needs to hear it, Rs. 300 iced lattes are not needs

2. 30% for your wants (that iced latte comes in here), and

3. 20% for saving (read: investing).

Naturally, it is extremely hard to cut down on your needs, and for most people, their wants are ever-growing. This is where that last 20% comes in. By investing it in mutual funds or stocks, you can multiply it instead of letting it sit idle in your bank account. This is a very good way to increase your overall income and have more money for the other two categories. The rule helps you understand and simplify your income, enjoy your wants, and save for the future as well. This is especially needed when you’re just starting to earn, and need to figure out your own personal relationship with money.

Let’s understand this more with an example. Suppose your income is Rs. 50,000 after taxes. This means all your needs should be covered in approximately Rs. 25,000, you should not spend more than Rs. 15,000 on your wants, and Rs. 10,000 you can save or invest.

Now, suppose you want to save up for a new gadget or a vacation. In that case, you can try to put aside, say, Rs. 5,000 every month from the Rs. 15,000 budget you have for wants, and spend the remaining Rs. 10,000 in the same month. If you are someone who does not have the idea or the wish to invest in stocks, a safer (and generally long-term) option is mutual funds. You can start a SIP (Systematic Investment Plan) of Rs. 2,000 and then gradually increase it.

Of course, it goes without saying, that as your income increases, so do the percentages. It then is your choice, if whether you want to splurge that Diwali bonus on a vacation, or add it to your total income and then apply the rule. The focal point here is that this is not a hard and fast rule; it is more of a suggestion to keep track of how and where you are spending your money — the one you slog day and night for.

Will you recommend this rule to someone, or try it yourself?

Let me know in the comments!

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