Savings planning is always confusing for beginners. To know how to build a solid base for your finances, check out this article.
Taking control of your money is not an easy job. It requires precise planning and execution. Any rush or overlook of risks can bring catastrophe to your finances.
While we all try to look for the easiest and most effective methods to achieve our financial goals, the abundance of available rules, tricks, and tips often overwhelms us.
What to do? Where to start? To avoid risk or take risk? What is the 50/20/30 rule? What is goal-based planning? Should I start saving early or follow the YOLO? - These questions are enough to misguide the minds of any newbie in the financial planning industry.
If you are too lost in this never-ending loop, let’s take a simple guide to basic savings-planning that you must know.
Rule #1: The 50/20/30 rule of budgeting
No matter where you try to look for a subtle savings plan, one thing is common for any financial advice- prepare a reliable budget plan. But how to actually proceed is the real ice breaker.
For a simple and effective start, you can follow one of the most widely appreciated rules of budgeting- the 50/20/30 rule.
Under this rule, you split your income (here, we are referring to the after-tax income- pay your taxes on time, it’s necessary:) into three slabs: the 50% slab, the 20% slab, and the 30% slab.
You basically spend, save, and invest according to these percentages. To understand better, here’s the catch-
-50% goes to your NEEDS
First things first, you can never avoid your needs- if you need something, you must spend to buy it. As per the 50/20/30 rule, the expenditure on these essential items in your consumer basket shall not exceed 50% of your income.
You do not have to compromise on having them, but you must not be reckless while spending on them. The bills (electricity, insurance premiums, medical bills, etc.) and things that you NEED to survive (groceries, etc.) are covered under this slab.
Remember that we are not containing entertainment expenditures like Netflix, etc. here.
Half of your after-tax income should go into making these life essentials available to yourself. In case the expenditure on them is exceeding, you know there is some problem that needs fixation.
You can start by avoiding dining out; opting for a modest car; shifting to a more convenient house; trying carpooling; cooking at home, etc. If you actually wish to achieve financial stability in the future, you may have to downsize your lifestyle for some time in the present.
-30% goes to your WANTS
The next 30% of your after-tax income shall go in spending on things that are not required for your absolute survival. You do not need these things, but you may want them to take a break or simply to entertain yourself.
Things that make you happy, perhaps, can be a new handbag, going to the gym, dining out, tickets to your favourite artist’s concert, etc. The spending on these must not exceed the 30% benchmark.
If you are stingy enough, you can even boil down some expenditure here and focus on saving wherever possible.
For example, instead of going out for dinner, you can cook at home or workout at home instead of going to gym or avoid getting that latest smartphone if your current one is working perfectly fine. It all depends on your choice and your financial target for the future.
- 20% goes to your SAVINGS
Lastly, the remaining 20% of your after-tax income must be saved and invested. Without investing, even your spending won’t be of any use in the future. There are various factors that can take down the value of your static money.
Ensure that you actively invest your time. Consider keeping one part in stable bonds or options like RBI bonds, NPS schemes, FDs, etc. that will give you stable returns. The second part should be invested in precious metals like gold.
And finally, the third part in some risky but profitable ventures like equities, shares, mutual funds, direct equities, etc. You may even consider investing in real estate in order to create immovable property.
Also, here you must take a future-oriented approach. Decide how you want your financial status to be in the future and invest accordingly.
Do not skip the necessary emergency fund and always make sure to put aside enough money that can help you survive at least 6 months in case any financial havoc hits in.
Now that you are aware of the basic guide to budgeting, here are other important rules that you must consider for a better financially secured future:
Rule #2: Get a hold of your debt
The second most important rule for any successful financial planning is to keep in mind paying-off the debts as soon and timely as possible. A debt is just an unnecessary pressure on your daily finances.
Do not leave it to the last moment. If you have credit card debt, just pay it as soon as you can. Even with a personal loan debt, it is unreasonable to stretch the time period.
This will not only improve your credit score, but will also create room for you to invest and save more for the future.
Also, getting rid of the debt is also necessary if you follow the goal-based savings and investment plan. For your short-term or long-term financial goals, a debt can pose a serious threat as it diverts your money from active investment.
For example, if you plan to buy a house in future, it will be very difficult if you are already under the burden of a loan or debt. In addition, this debt may even eat up your emergency funds- a risk you can’t afford to take. Therefore, keep in mind your goal and save accordingly.
Rule #3: Keep in mind your retirement plan
In case you are looking forward to the FIRE lifestyle, there is no way you can avoid huge spending contraction and a little minimalistic lifestyle at present. Even if you are not looking forward to retiring early, your financial planning would still revolve around the question of retirement.
At some point in life, you would want to take a long break and just enjoy life as it is. For that, you need a strong financial backup. Save as much as possible and, above that, invest actively.
Look for beneficial but assured investment options. Take some risk if you have to- being a risk taker is perhaps the only way to excel in the investment business.
Rule #4: Avoid being the House-Poor- The 28/36 Rule for mortgages
In case you are planning to invest in a house soon and that too on a mortgage, here is the 36% guideline for you to consider.
As per this rule, nothing above 28% of your gross monthly income should go towards your housing expenses while no more than 36% should go towards the debt payments (including housing mortgages).
So the first step for you to determine how much to spend on a housing mortgage is to calculate your debt-to-income-ratio. Once you have determined this, you can now determine what you can spend on housing without exceeding the 36% cap.
It is also advisable that when you plan to buy a house, the cost should not exceed 2.5 to 3 times your annual income- if it does, look for another one as that one is clearly not affordable for you.
In short, your housing expenses must be based on your debt and income. Never avoid these two factors while looking for a house.
Rule #5: Never ever avoid your emergency fund
The last rule of thumb for any successful financial plan is that you must never ever avoid your emergency funds. They are not just to provide you groceries when you run out of them, but also to help you during unforeseen calamities like accidents, serious health issues, loss of job, etc.
If you are unable to keep aside for 6 months, at least try to make it for 3 months and then keep contributing until you find them to be sufficient.
Many people commit the mistake of just keeping aside money in their lockers- do not do that. Ensure that even this fund is earning you something. Use a profitable savings account to manage your emergency fund and if you can, keep adding to it regularly.
In case you are just starting, you can achieve a good emergency fund just by starting to save a minimum 10% of your monthly income.
These were the rules of savings planning that are currently most sought-after. After years of market analysis, these can be considered the stepping stones for an utterly financially secured future. Try to follow these rules of thumb and grow your wealth.
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