It’s always good to find new ways to improve your budget. One simple, useful tool I’ve discovered is Rule 50/20/30. Developed by Harvard bankruptcy expert Elizabeth Warren and her daughter, Amelia Warren Tyagi, Rule 50/20/30 breaks living expenses into three broad areas: Essential Living Expenses (50%), Your Future (20%) and Lifestyle Choices (30%).
This guide helps you to quickly see where you are over- or under-spending and what the impact of that can be. For instance, if you find you’re overspending on Essential Living Expenses or Lifestyle Choices, you’re probably not committing enough of your income to your future needs, or allowing some flexibility to manage if things go wrong.
The percentages can also be adjusted to suit your own circumstances. Some people earn more than they need, and so don’t need to allow 50% of their income for essential expenses. Others don’t earn quite enough to cover their expenses, so may have to allocate a little more to this area.
The aim is to observe your spending and make the adjustments you need to gain balance. Containing your spending within these parameters can improve your chances of having a healthy and satisfying future, while still enjoying your life now.
Let’s look at how you can put this into practice…
Step 1: Calculate your total income (100%)
Write down your net income (after tax), which is the amount your employer pays into your bank account (e.g. $4,000 per month), plus your gross super contributions (e.g. $360 per month). In this example, your total monthly income is $4,360.
Step 2: Essential Living Expenses (50%)
Essential expenses differ from person to person, so you’ll need to think about the percentage that is most relevant for your circumstances. The 50/20/30 rule suggests 50% as a starting point ($2,180 per month in this instance).
Think about the bare essentials you need to survive—food, utilities, mortgage/rent. Make sure you only include things you really can’t live without. For example—if you would only be minimally affected by not having an item, then it’s probably a Lifestyle Choice and not an Essential. So, if you can catch public transport or walk to work, then your car is not an essential item. If childcare is absolutely critical for you to be able to work, then that is essential. (Definite exclusions here include Netflix and Jimmy Choo shoes!).
Include medical expenses that are essential to your health and minimum debt obligations. For example, include your minimum credit card payments in Essentials, but add the additional portion of your debt repayment to Your Future.
Knowing what you need to cover your essential living expenses helps you identify your bare minimum needs—say, if you suddenly lost 50% of your household income. Knowing what you can survive on can take a lot of strain out of such a dramatic income drop. This knowledge can also help you start planning for your future, as it gives you a minimum annual income target that you need to generate.
Step 3: Your Future (20%)
Your Future is all about your longer-term dreams and goals—including your emergency backup fund, super contributions and investments (regular savings investment).
The aim is to dedicate at least 20% of your total income to your future. Using our example, this would mean $872 per month (20% of $4,360). Of this amount, $360 is your existing employer super contributions plus $512 from your total income.
Step 4: Lifestyle Choices (30%)
Ah, the fun part! This is where all your wants come in—holidays, shopping, a long weekend…all the good stuff. But take a moment to really think about this. You’ve kept your essentials to the bare minimum, so this is the fund that covers things like Netflix, car costs and your unlimited mobile bill. You’ll probably find that you’re spending more on wants than you realise.
A gym membership may be a positive thing for your health, but it’s still a lifestyle choice (a want) rather than essential. Ditto, biscuits and ice cream (even though they’re part of your grocery shop!). Cautionary note: as you can see, the deeper you dig, the easier it is to get hung up on small details of your spending. Remember, the aim of this guide is to build your awareness of your spending, so the important question to ask yourself is: is this item really needed?
The key to success in applying the 50/20/30 rule is to keep it as simple and straightforward as you can. Used in this way, it can be a valuable guide to help you quickly identify areas where you might be overspending, and adjust your budget accordingly. The more you understand what is happening in this space and are able to adjust accordingly the higher your financial wellbeing is and the lower your financial stress levels are.