The 50-30-20 Rule of Budgeting
Elizabeth Warren mentioned this budget rule in her book, All Your Worth: The Ultimate Lifetime Money Plan and whenever my clients ask me if there is a rule or guideline to live by, I would often refer them to this-- but tweak it and customise it for them, depending on their willingness to save/ invest for themselves.
What the 50-3-20 Rule entails
After setting aside for taxes, we are encouraged to follow this guideline: to apportion 50% on necessities, 30% on desires and wants and the remainder 20% on savings and investing. The golden question is... Is this guideline an appropriate one for you?
For Young Single Adult earning $3,000 a month using the 50-30-20 rule
If you are a young adult, earning $36,000 per annum with no liabilities in Singapore, here is how the 50-30-20 rule will work. Disclaimer: the calculations are based monthly and I assume you pay your tax monthly instead of as a lump sum. Nett of estimated monthly income tax payment ($35), and the 20% ($600) that is taken away from your gross pay to go into your employee's contribution to CPF, you have about $2,365 left monthly. If we were to go by this rule, you will have about $1,182.50 (50%) for your bills, meals, transport, study loans and the adulting allowances that you will have to contribute to your parents. That leaves us with $709.50 (30%) monthly to buy your wants-- holiday tripping, that bag that you have been eyeing, the occasional splurge with your friends for avocado toasts and weekend brunches and the occasional online spree and voila, you will have about $473 (20%) left to save and invest and basically shore up your emergency cash-- which if I were to include the compulsory spends and the wants together, you will need about 24 months to save up this stash, before you can start investing the rest. It is a pretty depressing thought if you were to think about it-- because, you literally have no money to invest (until after 2 years) if you were to live by this principle. It is little wonder why people say "Money not enough"! Because if we prioritize spending, to treat ourselves better in the present, we often find ourselves struggling with planning for our future
Young Adult decides to change the budget equation
Let us have a work-around this: What if we change the equation a little for the young aspiring adult and ensures that she apportions $1,000 (42%) monthly to her necessities and basically eat caifan like the rest of her colleagues during work days and drink Yakun coffee instead of the barista coffees daily, allocates 1 fancy meal every fortnight with friends of no more than $100 per pax and allocates the remainder $300 (21%) monthly for holiday trips, she would have $865 (37%) excess monthly and she would only need to set aside 11 months of her excess cash as emergency funds before she starts to work her funds harder. (Note: she is still having a social life and maintaining her trips but she is now more able to start deploying her funds more wisely to work them harder).
Why should she do that and what is the game changer?
There are various reasons why I would encourage her to do that. First, as a new graduate, she is used to having $500- $800 monthly allowances and it is not a lifestyle compromise for her; in fact, in contrast, she has now about $1,500 to spend monthly now, a marked 100% increase from her "last drawn income". Second, what constitutes a "necessity" for this young earner will include basic food, clothing, transport-- the type of food, clothes and transport she partakes of are dependent on her cashflow/ salary. Hence, I would encourage the young adult to first live within her income means. I have seen too many young adults spending beyond their income range in their earlier years and hence end up not being able to control their budgeting in their later years because they do not have a good mastery of their finances. Third, if the young earner is able to save more, she is able to make the money work harder for her at an earlier stage and achieve financial freedom earlier.
Let me use the following illustration with the earlier example of the young adult, earning $3,000 monthly:
Suppose this young aspirant adult really apportions according to 50-30-20 principle, and assuming that she is now 25 and she starts deploying her funds to her favourite index fund*: Ceteris Paribus, by 35, she would have had an excess of $69,700. This is because she had to take 2 years to set aside her emergency cash because she decided to deploy a "Spend Now, Pay Later" mindset. The same lady, should she decide to 'Pay herself first" and watch her waistline, as well as her budget, and invest all the excess cash into the same index 13 months earlier than a subscriber of 50-30-20 would, she would have amassed approximately $154,000.
Hence, the question begets-- should a young adult, starting out at the workforce, be doing a 50-30-20 or reduce the needs and wants and increase his savings/ investment first? The rule of thumb of 50-30-20 is a great guide, but play by your rules and your thumb because not all thumbs are the same.
Afterall, our payscale does not remain stagnant for the next 10 years but our money attitudes will.
Delayed Gratification
There is a certain beauty in delayed gratification. The beauty is knowing that it is not a deprivation of your current lifestyle but a delayed and controlled one so that you need not spend many years of your later life exchanging time for more money. Today, if you were the 25 year old, earning $3,000 a month, would you want to have $69,700 or $154,000** in your account at 35? What is the lifestyle adjustment you will need to make today so that your future holds a little more promise for you?
What is the lifestyle adjustment you will need to make today so that your future holds a little more promise for you?
Disclaimer: This article is written solely for educational purpose, and does not constitute any opinions of the companies I am representing. There are a few assumptions that I have made in this article:
*I have referenced the returns based on S&P 500 annualized returns for the past 10 years and bench-marked it to be 10%.
** I have made assumption that the excess funds (after setting aside for emergency cash) are completely invested into the index.
Emergency Cash is defined at 6 months of your monthly expenses. In this article, I have included the amounts based on the individual's necessities spendings as well as "wants".
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