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Does the 50/30/20 budgeting rule work in India?

Posted on 14 Dec 2022
Author: Sayan Sircar

Tags: Budgeting

5 mins read
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This article shows you if you can apply the popular 50/30/20 budgeting rule for investing for your goals in India.

Does the 50/30/20 budgeting rule work in India?

What is the 50/30/20 budgeting rule?

The 50/30/20 budgeting rule, created by Elizabeth Warren in the book All Your Worth: The Ultimate Lifetime Money Plan splits your monthly budget into three categories:

you should spend up to 50% of your income on “needs.” These include mandatory items like rent/EMI, food, school fees, electricity/mobile bills etc.
you should spend up to 30% of your income on “wants” like entertainment, transport, clothes, and anything discretionary
the remaining 20% should be considered for investments and loans. This bucket will include all investments for financial goals as well as EMIs of loans

This article will examine what happens if an investor in India applies this 50/30/20 rule to their budget and investing plan.

Disclaimer: The purpose of this article is not to insist that you need to invest ₹X/month else your future is doomed. Instead, it shows you a way to understand thumb rules you will come across regarding budgeting and investing that you should understand before applying them to your situation. After all, we have heard this many times:

Personal finance is more personal than finance. - Tim Maurer

Why was the 50/30/20 rule proposed?

The purpose of the rule is to allow investors to get started with budgeting with a simple-to-understand thumb rule. It is also easy to implement if the investor needs guidance about how much should be invested for long-term goals like retirement.

The rule is suitable for people who need to get started, say if they are a new joiner on their first job. But it will be inadequate if you have invested for some time, as we show in the next section.

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Does the 50/30/20 rule work in practice?

The rule mandates that 20% of monthly income will go into EMI and investments for typical goals like retirement, house down payment and children’s education/marriage. The rule works only if this 20% is enough for these goals.

For simplicity, we will assume no EMI, only retirement as the goal, and the only lifestyle cost for retirement be the same as the mandatory bucket today. These assumptions are justified like this:

having no EMI means that we can divert the entire 20% for long-term goals
we are absorbing all discretionary expenses in retirement into the mandatory bucket to offset expenses like rent payments and children-related (like school fees) will not persist into retirement

Therefore to put it simply, for someone with ₹100,000/month income, can saving ₹20,000/month suffice to have a lifestyle of ₹50,000/month in retirement? If the obvious answer (“No, it is not”) is not immediately apparent, here are some simple back-of-the-envelope calculations for a person earning ₹100,000/month with retirement 25 years away:

₹50,000/month lifestyle in retirement starting 25 years from now needs a retirement corpus of ₹2.4 crores in today’s money. We will ignore the effect of inflation by assuming a very reasonable zero real returns on investment
₹20,000 is invested for 25 years. That leads to a corpus of 25 * 12 * 0.2 = ₹50 lakhs in today’s money

Therefore if you are only investing ₹20,000/month at zero real return, you better have the difference, i.e. 2.4cr minus 50 lakhs, or ₹1.9cr already invested. If you do not have ₹1.9cr, then 20% will not be enough.

Also read
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Understanding how 20% is not sufficient

To understand these calculations, we have assumed that salary hikes, lifestyle expenses and returns from the retirement portfolio all happen at the same rate. We have covered this topic here: How much returns should you expect from your retirement portfolio?.

We can therefore do simple multiplication like this:

Retirement corpus (C) = Years left to retire (Y) * Annual expense (E)

Corpus that can be reached (C) = Annual savings (S) * Years left to retire (Y) + current investments (V)

Simplifying the two, the current annual savings is sufficient only if

S * Y + V ≥ Y * E or,

S ≥ E - V / Y or,

Annual Savings ≥ Annual Expense - Corpus saved / Years left

If you do not have sufficient corpus saved, saving only 20% will be insufficient. If you are starting, be aware that saving less than what you should means that you will miss your goals. Therefore be mindful of this limitation when you are applying the rule.

What should the investor do instead?

We all look for thumb rules that simplify our lives. However, there might be better things to do in some cases, given your unique personal situation. Therefore it is better to learn the frameworks that work for all investors and apply them to your need. Here are some resources that will help in this matter:

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