Secret to financial freedom: Why the 50/30/20 savings rule is a win

JOHANNESBURG — In this excellent article, independent financial advisor and asset management consultant Candice Paine outlines some key tips to becoming financially free by explaining the 50/30/20 rule. It’s great advice for anybody looking to fine-tune their personal budget and bolt on a simplified but effective focus to it. – Gareth van Zyl

By Candice Paine*

No, I am not going to tell you to forego the daily cappuccino or take packed lunch to work. It seems cancelling the DSTV and never eating out again is an archaic way to save and let’s face it, even though you stick to a draconian budget, your savings don’t grow and money is still a worry.

Candice Paine

Enter a decade old savings model called the ‘50/30/20 Rule’ which splits your budget into three groupings and if applied correctly really can lead to financial freedom. I do wish this was my clever invention, but all credit goes to Elizabeth Warren and her daughter Amelia Warren-Tyagi who penned ‘All Your Worth’ back in 2005. This powerful little book outlines a money management model which is both applicable and sensible. Ms Warren is a Harvard Law Professor who has spent a lifetime trying to raise consciousness as to the state of American’s personal balance sheets. It seems they are as bad as ours.

The way it works is to divide your after-tax income into three groupings –

50% is for ‘Must Haves’ – these include living expenses and essentials like rent or mortgage payments, utilities, groceries, school fees and transportation.

30% is for ‘Wants’ – this is everything you want, but don’t necessarily need. (However, life is short and everyone deserves fun otherwise what is the point of all the ‘Savings’ and the ‘Must Haves’)

20% is for ‘Savings’ – this covers saving for retirement, saving for goals and debt reduction.

To expand a little more because it can get confusing – what goes where. ‘Must Haves’ cover all expenses necessary to live, but no indulgences. E.g. a gym membership is a ‘Want’ and not a ‘Must Have’ because you can find free ways to exercise if necessary. DSTV is a ‘Want’. Mortgage payments, medical aid, utilities, transport and food are all ‘Must Haves’. Eating out is a ‘Want’. I think you get the picture.

Ms Warren goes on to explain that the challenge to keep within or close to the three groups means not only cutting down on ‘Must Haves’ and ‘Wants’ but looking at the size of the expense in the category – what do I mean by this?

In our parent’s day, creditworthy meant something – it meant you could actually afford the debt and the rest of your lifestyle. Today a bank will lend you money to buy a car and a house you can’t easily afford. And then they’ll happily give you a credit card for the rest.

This makes it incredibly difficult to keep ‘Must Haves’ within 50% of your taxable income.

Read also: Candice Paine: Investing – the 9 things you can control

The book has a lot of detail about how to allocate expenses, but the overarching message is that if you can’t get your budget within 50/30/20 – you need to make a plan. This may even mean moving home or downgrading your car or dare I say it, changing schools. This is the sacrifice required to gain financial freedom or peace of mind.

Now we move on to arguably the most important grouping – ‘Savings’ at 20%. This will include saving for retirement, saving for goals and paying down debt. Remember, the good debt/bad debt story. Get rid of credit card, store and car debt as soon as you can because this is NOT a saving. Paying extra into you mortgage IS a saving and will benefit you in the long run. The table below shows you how quickly savings can grow and if you relegate this to a debit order or habit, when you look again, you’ll be a saver.

Read also: Candice Paine: 5 indications you’re not taking your wealth seriously

You need to view each grouping as a marshmallow – they give a little to accommodate the others – but do try to be as rigid as possible especially with ‘Savings’ and ‘Must Haves’ and of course keep ‘Wants’ below 30% if possible.

Elizabeth Warren

The refrain that “I can’t do this” – I am just not able to get my ‘Must Haves’ to 50% probably means you aren’t trying hard enough. Have a close look at the debit orders that fly out of your account each month or the contracts you’ve signed and decide if these can be reduced or eliminated altogether. It goes without saying that you probably won’t be able to get your budget in-line in one afternoon, but the proposal is that with constant monitoring and trying, the closer you get, the more in control of your finances you will be.   

Then a last word. If your ‘Must Haves’ are well within 50%, don’t use this as a green light to go hog wild on spending. You are one of a very fortunate few who is now able to start building real wealth and achieving financial freedom and peace of mind probably within a short period of time. It behoves you to do this and teach others how to in a country where financial literacy is low and savings rates even lower.

Ms Warren’s vision was to give people a framework to manage their finances which would make sure you paid your way (‘Must Haves’), had some fun without the worry (‘Wants’) and saved for retirement and the other big-ticket items (‘Savings’). If you have no idea where to start, this is as sensible a place as ever.

  • Candice Paine is an independent financial advisor and an asset management consultant.