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