Managing our money optimally and taking control of our finances can seem overwhelming, but there are certain parameters that can simplify the process for us and serve as a guide to building a solid financial foundation. Among them is the 50/30/20 rule. This is a highly effective tool for distributing our income in an optimal way that ensures we can meet our needs, indulge ourselves, and reach our long-term financial goals. We are going to look at what this rule consists of and if it adapts to your needs. We are also going to share why we do not follow it, despite firmly believing that it is one of the best ways to manage our income and is a guide that everyone should use as a base. This rule consists of dividing our monthly income into 3 main categories: needs (50%), wants (30%), and savings and investment (20%).
1️⃣ Category: Needs (50%)
This category covers all essential expenses for your daily life. Imagine all those items that you need for your day-to-day. This includes things like: Housing: rent or mortgage, Food: groceries (excludes eating out at restaurants or food delivery), Utilities: electricity, water, gas, internet, etc., Transportation: gasoline, maintenance, tolls, public transportation, etc., Insurance: health, car, home, etc., Debt payment: student loans, car loan, etc. The most common argument against this rule is: "50% of my income is not enough to cover all my needs." And this is something very common, but for the most part, it is the consequence of maintaining a lifestyle that we really cannot afford based on our income. If 50% or more of your income is going solely towards housing, we regret to tell you that you are not managing your money well. Mind you, we don't say this to make you feel bad or anything similar, it is simply a reality. And if this does not change, your financial future is not going to be very promising. So if you are in a situation where 70%, 80%, or even more is going towards needs, it is necessary for you to take action. To be very transparent, there are only 2 things you can do: reduce your expenses or increase your income, and adjust your lifestyle accordingly. This 50% of your income allocated to needs ensures that you cover your expenses without compromising your well-being or your financial future.
💡 TIP: A person's main expenses are usually centered on housing, transportation, and food; and this is where the greatest adjustments can usually be made to reach that 50% goal. There is absolutely nothing wrong with living in a smaller apartment or not driving a car of the year while we take control of our finances and focus on building a financial future. We can get to have everything we want, but we must do it gradually.
2️⃣ Category: Wants (30%)
In our budget there can (and should) be a space for the things we like and enjoy doing. That is why in the 50/30/20 rule there is 30% allocated for wants. What does "wants" include? Literally, whatever you like and enjoy doing. It could be travel, trips to the cinema, restaurants, concerts, or even clothes, accessories, and electronics, or activities you enjoy doing like an extreme sport or similar. The possibilities are limitless; but your budget is not, unfortunately. But the fact that your budget is not limitless is not a bad thing. In fact, this makes us appreciate even more the things we want and enjoy doing, while also allocating a portion of our income to savings and investment to ensure our stability and financial future, which is where category #3 comes in.
3️⃣ Category: Savings and Investment (20%)
The last category, savings and investment, is the one that many like the least nowadays, but the most important for our future. We always say that many people find it difficult to save and invest for their future because they see it as something distant and even foreign, despite the fact that it is ourselves. It is no easy task to visualize oneself 15, 20, or 30 years from now and plan for it when in many cases we don't even know what we want to do in the coming weeks or months. But remember, your "future self" will greatly appreciate that you took control of your money and decided to save and invest early. That is a guarantee of financial peace of mind and perhaps the best thing you can do today for and to yourself. Here the idea is to allocate 20% to savings and investments, and set goals little by little. From this 20%, many goals can arise in a specific order that ensures financial progress, including building our emergency fund (3 to 6 months of fixed expenses available at all times), savings for short and medium-term goals like buying a house, a new car, etc., and of course savings and investment for our retirement, whether through a plan like a 401(k), an IRA, or even a regular investment account if we don't have access to those types of tax-advantaged accounts (if you live in another country, this is definitely not a limitation). Ideally, you should invest at least 10% of your income for retirement. Once we have completed our emergency fund and are on track with our short and medium-term savings, if we can bring this percentage to 20%, it will be even better, since this is the percentage considered appropriate to be able to reach retirement and maintain the same lifestyle that we lead today.
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What if it doesn't work for me?
It is a reality that this rule cannot be adjusted to 100% of people for different reasons. Perhaps for someone it is truly impossible to cover their needs with 50% of their income and they need 70% for it. In that case, it is essential to make adjustments to our budget that do not sabotage our financial future; therefore we must make sacrifices, at least in the short term, and reduce our budget for wants to be able to allocate that 20% to savings and investment. A big mistake that many people make is that they prioritize needs and wants over savings. We should automate our finances so that those savings are the priority, and then manage the rest of our expenses with the remaining 80%. If you earn $3,000 net per month, try to automatically save $600 and have $2,400 available for your expenses (needs and wants). According to the 50/30/20 rule, this implies that you must allocate $1,500 to needs and the rest, meaning $900, to wants.
If $1,500 is not enough for your needs but you need $2,000, for example, you can reduce the budget for wants to $400 and start focusing on increasing your income or restructuring your needs so that they represent 50% of your income instead of 66%.
If it is currently impossible for you to reach that 20% in savings because your financial situation is truly deteriorated, make an effort to start with 10% and adjust little by little, either by restructuring your budget or increasing your income, to reach that 20%. It is a great expression of self-care!
Why we do not follow this rule
Although we believe that this rule offers great benefits and helps many people to optimally manage their money thanks to its simplicity, priorities, and the balance it offers, it is not a rule for everyone. In fact, we do not follow it.
Why? Well, saving and investing 20% of our income will allow us to retire and give ourselves a lifestyle similar to the one we have today, which gives a lot of peace of mind, but this implies a traditional retirement age of 65-67 years.
If you want to retire before the traditional age, the truth is that saving and investing 20% is not going to be enough. Especially because before the traditional retirement age you will not have benefits like social security, so you are going to depend 100% on your assets to be able to live, if indeed you want to reach that goal.
In our case, since we were young we decided 2 things: the first is that we did not want to retire at that traditional age of 65, and the second is that upon retiring we do not want a lifestyle like the one we currently lead. We want a better one.
Therefore, we decided to be truly aggressive for more than a decade with our savings and investments, in a way that allows us not only to retire before the traditional age but to do so with a lifestyle somewhat better than the one we currently lead. At one point, we managed to save 70% of our income without making major sacrifices in our lifestyle (do not think we ate rice and beans to save money!).
Instead of renting the biggest and most luxurious apartment and having the car of the year, we focused on increasing our income without inflating our lifestyle, and at the same time increasing our savings and investments to be able to buy the most valuable resource there is: time.
For us, it was and continues to be a matter of priorities. What do we prefer as a couple or individuals? Spending $300 each month on a dinner to post the photos on Instagram so everyone sees the "fancy" places we go to dine because "we are successful" and people need to know it, or spending $50 on a dinner at a place we already love and saving those $250 to contribute to a Roth IRA?
One option implies immediate satisfaction and "looking good" socially; the other implies delayed gratification but with a much greater impact on our future, since we will be able to invest our time as we wish instead of having to be working for decades in a place that does not even fulfill us, counting the days for the moment to stop doing it to arrive.
The truth is that thanks to those decisions we made at the time, which we did not even consider sacrifices but rather acting rationally taking all variables into account, we were able to save and invest enough to decide to dedicate 100% of our time to Endeuda2 in 2022, even though we did not earn as much as in our traditional jobs. This fills us much more and makes us infinitely happier, without sacrificing our financial future because we have been taking care of it for years.
If we had not saved and invested aggressively during all this time, the truth is that we would have never felt prepared to take the step because we would have had very high financial stress. So we can confirm that thanks to those past decisions, today we are living a much fuller life with more purpose. All thanks to having a financial plan and carrying it out!
Work and manage your finances based on yourself, not on other people's expectations. In the future, those small decisions you made over the years are going to make all the difference.
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