The 50/30/20 Budgeting Rule Could Be Dangerous
What is your biggest budgeting mistake? Not doing a budget. What is your second biggest mistake? Using arbitrary one size fits all rules like 50/30/20 that are all over the internet. I almost ruined my finances, before I was a financial advisor, and here’s what I did to get back on track.
What is the 50/30/20 Budgeting Rule?
This budgeting guideline makes budgeting simple by allocating your earnings in this way:
• 50% on needs (housing, food, insurance, utilities, etc.)
• 30% on wants (new clothes, vacations, new phone etc.)
• 20% on savings (your financial goals, eg. Emergency funds, home ownership, retirement etc.)
The Challenges with the 50/30/20 Budgeting Rule
1. It Creates an Imbalance of Financial Priorities: This rule, gave me a false sense of security while derailing my finances. How? When I had less financial responsibilities, it made me comfortable to:
- incur more expenses than I should have (e.g. expensive car loan repayment),
- splurge more on my wants, like clothes, than I would have; and
- save less toward current and long-term assets than I could have. I thought I was doing great, until I wanted the deposit for my first home in two years!
2. Ignores the Realistic Cost of Your Financial Goals: I did the calculations for the down payment on the house. If I focused on saving only 20%, as the rule urged me to do, I would have:
- saved less than my goal required,
- inflation would have increased the cost of the goal; and 3) it would take me 10 years to achieve my goal.
Additionally, since I had multiple financial goals, splitting that 20% across all my financial goals would delay my home goal!! When I calculated the amount needed for my deposit, I needed to save 85% of my income to have it in two years instead! I had an immediate panic attack but now I knew what I need to do.
3. Encourages You to Grow Your Expenses to Keep Pace with Salary Increases: I had a lifestyle of spending 80% of my earning on needs and wants a.k.a. liabilities. Think about this.
Stage of Life |
Net Salary |
Needs = 50% |
Wants = 30% |
Savings = 20% |
Younger You |
$100,000 |
$50,000 |
$30,000 |
$20,000 |
More Mature You |
$500,000 |
$250,000 |
$150,000 |
$100,000 |
The 50/30/20 rule would make you comfortable spending $400,000 on liabilities and only $100k towards creating long-term assets needed to generate income for your retirement years. This is the slippery slope towards which I was headed.
The Best Alternative
I achieved my goal of home ownership in 2 ½ years!! How? Since I could not save 85% of my then income, I did the following: 1) set a target of how much I needed to invest each month: 2) earned from my talents and negotiated better salary offers, 3) reduced my expenses; and 4) automated my investments to my goal account.
Written by: Michelle Sinclair-Doyley, Corporate Manager, Group Financial Partnership Support & Financial Education