When we refer to financial planning, investments pop-up in our heads immediately. Growing your wealth, meeting your goals, accumulating assets – all of these need investments. However, in order to meet these financial targets and goals, it is critical that you manage the most important asset which enables all the others: your income.
The first step to managing your income is protecting it in the event of emergencies through adequate insurance plans. Once you have secured your income, the next step is to ensure that you manage it well enough to keep building up your investment capital steadily. This can be achieved through the simple process of budgeting.
The 50-30-20 rule of budgeting has become increasingly popular given the simplicity of the concept. It recommends splitting your salary into the following buckets:
- 50% in needs (such as rent, groceries, insurance, etc)
- 30% in wants (for trips, outings, restaurants, etc)
- 20% in savings (to save and invest towards goals)
While this rule provides a great starting point, managing and optimizing your finances often isn’t as straightforward and calls for greater granularity in budgeting. To provide greater clarity, we break down the budgeting guidelines further into actionable chunks in this blog post.
The 40-20-20-20 rule
Needs, wants and savings are broad categories that may hold different connotations for different people. To address this, we recommend the 40-20-20-20 rule to split your salary based on more tangible expenses.
- 40% in loans, housing and insurance. These are critical components of your finances, which form the foundation of a robust budgeting plan. To break things down further:
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- 30-35% in loans and housing. Loans help us achieve leverage and get to our goals faster. Housing, either rental or mortgage, puts a roof on our heads. Your spending on paying back your loans and housing shouldn’t exceed 30-35% of your income ideally. We have lumped loans and housing together as housing would be part of loans, in the form or mortgage, for most people. For those who rent, the same guideline applies in terms of percentage. Learn more in our blog post on how much loan you should take.
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- 5-10% in insurance. Insurance protects our savings from life’s uncertainties. Your spending on insurance plans such as life, critical illness and health insurance should fall between 5% to 10%. Low insurance spending could indicate insufficient coverage as per your income levels. High insurance spending could indicate subscription to high cost plans – an indication to review your plans and explore lower cost term based solutions.
- 20% in basic living expenses. These expenses comprise daily living expenses which are important for sustenance. This includes household expenses such as groceries, utilities and kids’ expenses, as well as personal expenses such as clothes, transportation, mobile and internet.
- 20% in leisure expenses. These include any expenses that are meant to help you unwind, explore hobbies and passions such as holidays, fine dining, painting class, etc. While not a necessity for your sustenance, these ‘personal treats’ are certainly important to ensure you can continue to stay motivated and work hard, and stay on track to achieve your dreams.
- 20% to be saved, invested and put aside for goals. This is what determines how comfortably you will retire, how many properties you will own and how many goals you will achieve. If you are saving around 20% of your salary, it is considered healthy and puts you in a good place to enhance your life. If this number falls below 10%, it is considered critically low and warrants a scrutiny of your budget. Once you have saved these funds, make sure you invest it in the right places to beat inflation and ensure your finances are not eroded in the long term. Read more in our blog post on how keeping the funds stowed away in a bank account or fixed deposit might be detrimental to your financial health.
Bottom Line
We all know that saving and investing is important in order to achieve our life’s dreams. Creating and following set strategies to execute your saving and investment plans is essential to keep your goals on track. The 40-20-20-20 rule is meant to provide you a baseline to kick-start this process.
In the coming weeks, we will be creating targeted tools to assist you in your saving journey. Stay tuned!