Beginners may opt for 50:30:20 strategy for simplifying budgeting

Evolved users should opt for the traditional approach of tracking expenses and eliminating frivolous ones

Household financial savings moderated in the third quarter of 2020-21 (FY21) to 8.2 per cent of GDP. This was the second consecutive quarter of moderation, according to data from the Reserve Bank of India. Even though household liabilities moderated, this was more than offset by weakness in the growth of household financial assets (like deposits, life insurance funds, provident and pension funds, and so on).

At a time when many households have suffered job losses and reduction in business revenues, there is a need to rein in expenses. And the best way to do so is by developing and sticking to a household budget.

Those who already have household budgets need to revisit them. Jharna Agarwal, head, Anand Rathi Preferred says, “Household budgets need to be re-visited every year as one’s situation keeps changing.” Check out which of these two budgeting strategies suits you better.

The 50-30-20 strategy

The beginner may use the 50-30-20 strategy, which simplifies budgeting.  Rishad Manekia, founder and managing director, Kairos Capital says, “This rule works on the principle of splitting your income into three baskets: 50 per cent for your needs, 30 per cent for your wants, and 20 per cent for your savings and debt.”

In other words, 50 per cent of your paycheck should go toward things like rent, EMI, bills, food, credit card payments, insurance premiums, and so on. Another 30 per cent should go towards the things you want, such as vacations, eating out, shopping, etc. And 20 per cent should go towards saving and investment.

This budgeting strategy has a few drawbacks. Manekia says, “The first issue is that what falls into the category of need, want, or saving is very subjective. It is entirely up to the user how he categorises his spending.” There is a need to be honest in drawing the line between what constitutes a need versus a want.

Manekia adds, “The second issue is that the 50-30-20 rule does not work in many situations.” For example, someone earning Rs 5 lakh a year and living in Mumbai may find it difficult to keep his needs under 50 per cent of income.

While this rule is a good starting point to build the saving habit, it should be tweaked once a person has gained experience at budgeting.

The traditional approach

Here, the first step is to develop greater awareness about your current financial position: your own and your spouse’s monthly income, and income from other sources. Says Balwant Jain, investment and tax expert: “The second step is to understand your spending pattern by tracking your expenses. There is a huge gap between what people think they spend and what they actually do. Track expenses for at least two-three months.”

Don’t ignore expenses that occur at higher periodicity. Agarwal says, “Don’t overlook quarterly and annual expenses, like school fees, insurance premiums, festival spending, etc.”

Analyse the data you have gathered. This will provide insights into the areas where you can trim expenses. Discretionary expenses are likely to offer the maximum scope for belt-tightening. On the non-discretionary side, switching to a loan with a lower interest rate can put more money in your hands. Similarly, exiting traditional insurance plans that neither offer adequate protection nor offer good investment returns can help.

Once you have started saving under various categories, ensure there is a plan for every rupee saved. Begin by building an emergency fund and then go on to invest for goals like purchasing a house, children’s education, your own retirement, and so on.  

Seek professional advice from a certified financial planner if you need hand holding for the budgeting exercise.

                                               

                                                 Compartmentalise to inculcate discipline

• Allocate money to investments, non-discretionary and discretionary expenses at the start of the month

• Spend under the first two heads right at the beginning of the month

• Don’t wait until the end of the month to invest the money that is left over

• Try to stretch the money allocated for discretionary expenses till the end of the month

• If it runs out earlier, defer your expenses and don't steal from the savings bucket