TheWhatIfy 8 months ago

thewhatify #personal-growth

Kakeibo, RAG method and 50-25-25 Rule to Become Rich in India

The 50-30-20 rule does not work for Indians, and in this blog, I will walk you through some of the reasons why. More importantly, if you're following this rule, you are not likely to become financially independent anytime soon in India.

About 50-30-20

This rule was introduced by U.S. Senator Elizabeth Warren in 2005 in her book All Your Worth. According to this rule, 50% of your after-tax income should be spent on your needs, such as rent, groceries, and insurance. 30% of your after-tax income can be spent on your wants, such as gadgets, holidays, hobbies, etc. The remaining 20% of your after-tax income should be saved and invested in things like mutual funds, stocks, property, etc.

However, Elizabeth Warren designed this rule for people living in the U.S. due to certain conditions that do not apply to Indians.

Let me explain one of those reasons:

American vs. Indian Education System

In America, education from kindergarten to 12th grade is absolutely free. In fact, $1.3 trillion is spent by the state and local governments to fund this education. About 87% of American children attend public (state) schools, meaning parents in the U.S. spend zero money on their children's education from kindergarten to 12th grade. As a result, Americans can afford to allocate about 30% of their income to wants such as hobbies, vacations, etc.

On the other hand, in India, many parents avoid sending their children to government schools—not because they don't want to, but because the Indian government spends only about one-tenth of what the U.S. spends on education, while India’s population is four times larger. Naturally, the quality of education provided in Indian government schools does not match what is available in the U.S., leading parents to enroll their children in private schools.

Today, sending a child to a private school in India can cost between ₹10,000 and ₹20,000 per month. For families with two children, this expense can range from ₹20,000 to ₹40,000 per month. If we project these costs over a 12-year period, parents could end up spending between ₹28 lakh and ₹56 lakh solely on their children's education from 1st to 12th grade.

Therefore, in the Indian context, spending 30% of our income on discretionary wants does not seem feasible.

China: 10:1 Rule

Chinese people are known for being very good at managing their money. One of the famous rules they follow is the '10:1 rule,' which is widely practiced in China. This rule simply means that if you're earning 100 rupees, you should only spend 10 rupees. While this rule is practical for ultra-wealthy individuals, especially those earning around ₹10 lakh per month, allowing them to comfortably spend ₹1 lakh, living on 10% of your income is only feasible when you have a significantly high income.

India

In India, most people earn somewhere between ₹50,000 to ₹1 lakh per month. So, how do we manage this modest income and still maintain financial health? That's what I'm going to discuss. To manage our income effectively, we need to learn four very important financial concepts:

The Japanese secret of money management, called Kakeibo.
My favourite, the 50-25-25 rule.
The RAG method, a project management technique used in IT.
Lastly, where to invest this modest salary so that you remain financially healthy.

Let me walk you through these four concepts in very simple terms.

1. Kakeibo

The Japanese money management technique is called Kakeibo. "Kakeibo" literally means "household financial ledger." It was invented by Hani Motoko, a famous Japanese journalist, in 1904. As part of this methodology, Japanese men would traditionally give all their income to their wives. I don't know how many Indians are doing this.

Now, what the wives would do with this money is categorize every single expense they made throughout the month into four broad buckets. They would physically write down each expense in a ledger called Kakeibo and categorize it into the following four main buckets:

Needs
Wants
Cultural spend
Unexpected spend

This system helps them keep a good handle on where their money is going. This becomes very important for Indians, especially with so much spending happening through UPI, where many people lose track of their expenses.

Here’s what you need to do: Get a physical notebook and start categorizing your expenses into these four buckets. But I’m going to take this a step further and break these categories down into something more relevant for us.

1. Needs:

We will break down the "needs" category into six subcategories:

Rent
Food
Clothing
Travel for work
Utility bills
Insurance

If you’re wondering why insurance is included in needs, it’s because medical inflation in India is at an all-time high, currently running at 15%, which is twice the retail inflation. On average, Indians are getting heart attacks 10 years earlier than Americans. Without health insurance, a single hospital bill could wipe out your entire financial plan. So, health insurance is definitely a basic necessity.

2. Wants:

The "wants" category can be broken down into four subcategories:

Hobbies
Passions
Getting wasted (alcohol, cigarettes, etc.)
Upskilling (investing in learning new skills)

3. Cultural Spend:

We will break this into three subcategories:

Festival expenses (Durga Puja, Diwali, Holi, Christmas, etc.)
Donations (if you’re donating to charity, note it here)
Family rituals (if you’re giving gifts or money to family for special occasions, include it here)

4. Unexpected:

This category has no subcategories because unexpected expenses, by definition, are things you cannot predict.

Once you categorize your expenses into these four buckets, you will have a much clearer picture of where your money is going.

Now, this leads us to the second important concept:the 50-25-25 financial rule.

2. The 50-25-25 Rule

The 50/25/25 rule suggests that:

50% of your after-tax (in-hand) income can be allocated across four major spending categories (needs, wants, cultural expenses, and unexpected expenses). This means you should limit your spending in these areas to 50% of your income.
25% of your after-tax income should be invested for short-term goals (e.g., emergency funds, travel plans, etc.).
25% should be spent or invested in long-term goals (e.g., retirement savings, buying a house, etc.).

Now, focusing on the first 50% allocation, you may ask: "If I earn ₹50,000, are you asking me to spend only ₹25,000 on my needs, wants, cultural expenses, and unexpected costs? How do I manage that?"

To explain this further, I will walk you through a project management concept that helps break down how to spend within these four buckets efficiently:

3. The RAG method

People in IT will understand this method. They use a powerful concept called the RAG status. RAG stands for:Red,Amber and Green.

This is similar to a traffic light system:

Red means stop.
Amber means wait.
Green means go.

Now, let’s assume your salary is ₹50,000. I'm saying that 50% of that, which is ₹25,000, is the maximum you should spend across the four spending buckets (needs, wants, cultural, unexpected).

But if you feel that ₹25,000 is too little, you can categorize your expenses using the RAG method:

Red: These are the subcategories that are not important to you, and you make a conscious choice not to spend much money here.
Amber: These are categories where you have limited control and have to spend regardless.
Green: These are the categories where you definitely want to spend because they are important for your lifestyle.

This method helps you prioritize your spending within the ₹25,000 limit each month. Here’s how RAG works:

Example: In the "needs" bucket:

Red: Rent is a red category for David. He prefer to spend very little on rent. For example, David moved to London, there he lived in a studio flat for 3 years, which cost him around £700 per month. At that time, his take-home salary was about £3,200 per month, so he was spending less than 20% of my salary on rent. Meanwhile, many of his colleagues were renting 2-bed rooms flats for £1,500 to £1,600 per month, which ate up around 50% of their income. But for him, living in a larger space wasn't important.

Red: Another red category is clothing. David hardly spend money on clothes. For example, the t-shirt David wears cost just ₹500. He also wears shorts, which he finds very comfortable, He is perfectly fine not spending on rent or clothing.

Amber: Travel for work, utility bills, and insurance are all amber categories. You don’t have much choice here, so you have to spend on them.

Green: Food is a green category, where David spend more. For instance, he eats almonds every day, and he only buy premium quality Mamra almonds, which cost about ₹500 per kilogram. He doesn’t compromise on food, and he is happy to allocate a bigger portion of his budget here.

To apply this method yourself, take your ₹25,000 and find your own RAG priorities for each spending bucket. Use the Japanese Kakeibo method to note down all your expenses in these categories and assign them a RAG status. This way, you can consciously identify which expenses are red (low priority), amber (moderate priority), or green (high priority), and prioritize your spending accordingly.

4. Important Concept

The fourth and very important concept that will lead you to financial freedom is knowing where to invest the remaining 50% of your salary. This remaining 50% should be divided into two broad categories:

25% should be saved and invested for short-term goals.
The remaining 25% should be saved and invested for long-term goals.

However, before you start any investments, it’s crucial to ensure you have an emergency fund in place. Please do not make the mistake of investing without first having your emergency fund set aside.

Now, let’s discuss the 25% of your income that should be invested in short-term goals. What are short-term goals? These are goals you want to achieve within the next five years. For example: