BackFIRE: Did the 50:30:20 rule work for early financial independence?
Thumb rules are a great way to build saving/investing habits but sticking to it without any modifications, doesn’t guarantee Financial Freedom. Let us understand the concept behind such thumb rule
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The Book “All Your Worth:The Ultimate Lifetime Money Plan" by Elizabeth Warren entails the concepts of 50:30:20 Thumb Rule of Personal Finance states that 50% of after-tax income should be spent on must or necessarily expenses, 30% on debts or lifestyle and the rest 20% on savings.
This rule can help any individual to build a corpus for their emergencies & retirement but in emerging countries like India, where the Household Savings Rate is already above the thumb rule but still many individuals are struggling or finding it difficult to build a sufficient retirement corpus.
Similarly, when it comes to FIRE (Financial Independence & Retire Early), a concept which emerged from the Book “Your Money or Your Life" written by Vicki Robin and Joe Dominguez. Focuses aggressively on achieving early Financial Independence with Higher Savings Rate & Simple Living lifestyle concept.
Let's say, if a 28 years old unmarried is earning ₹10 lakh/yearly who lives with his parents has less household expenses (considering his parents are not dependent on his income) but spends most of his income on lifestyle as compared to a person who lives separately due to job location/work profile has different lifestyle spending pattern. And if both saves 25% of his income then, it takes 3 years of work to save for 1 year of living expenses. That means it took them 30 years to save for the next 10 -15 years of their living expenses. In this scenario, both will build similar corpus, ignoring other factors - though the former one has the maximum possibility of building more corpus but opt for more spending than investing.
In Insurance also, 20 times of your income should be of life cover but what if his income changes after 5 years & the person didn't do any top-up of his life insurance coverage regularly.
Then the coverage of ₹50 lakh will be insufficient after 10-20 years as the value of money has decreased over the period.
Thumb Rules are a great way to build saving/investing habits but sticking to it without any modifications, doesn’t guarantee Financial Freedom. Understand the concept behind such Thumb rule & the country from where it originated from. Because every country has different costs of livelihood & rising inflation rates thus, resenting the individual like us to adjust these generalised thumb rules as per the living standard & personal finance goals.
To create our Personal FIRE Plan, we need to:
- Identify Personal & Financial Goal
- Measure it in monetary Terms with the help of tools like SMART Goal.
- Literate ourselves about personal finance or consult with the Fee Only Advisors.
- Need to find the Required Inflation Adjusted corpus
- And then determine how much percentage need to save regularly to achieve the said corpus.
- Lastly, Time Review it
The Said corpus can be called as the FIRE Number which can motivate you to increase Personal Savings rate & achieve Early FIRE.
Resultantly, leaving us the counter to not follow the generalised thumb rule as the advice and determine our own higher savings rate & period to achieve the same.
The higher the Savings Rate in the Right Financial Instrument increases the possibility of achieving FIRE Early.
Disclaimer: The view shared above is the author's personal views based on the client interactions & research. Please consult with your SEBI Registered Investment Advisor or CFP before taking any Financial Decision.
Sanchit Taksali, is a Certified Financial Planner with more than 7 Years of Financial Industry Experience. Currently, he is handling the Wealth Management Department at the Sebi-registered investment advisory company Kedia Capital Services. He can be found on Twitter at @sanchittaksali and on Instagram at SanchitTaksali.
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