Setting up a budget can be daunting. So much of the advice seems to call for digging up impossible amounts of paperwork and receipts, only to invest hours in front of the calculator. Not exactly how you want to spend your precious free time! But, take heart: The 70-20-10 rule can help. A percentage-based, easy-to-apply formula, this tried-and-true budgeting rule uses simple underlying concepts to help you keep your personal finances in good order. Which is a very good thing! With smart cash management, you’ll be growing your wealth and avoiding debt traps today and tomorrow.
What is the 70-20-10 rule?
More specifically, the 70-20-10 rule is a way to allocate your monthly income into three categories — living expenses, debt repayment and short-term savings, and investing and donations. Using these categories can help organize the way you think about your income — how it comes in, and importantly, how it goes out. It’s a simple and often very successful way to get a personal budget in place.
Let’s take a closer look at each of the three components of this budget tool.
70% for Living Expenses
Living expenses are exactly what they sound like — expenditures you need or want to make each month. To see how much of your post-tax dollars go toward these costs every month, you’ll do a little math. You’ll add up the monthly payments that cover essentials such as housing, utilities, food, childcare, and medical expenses. It also includes expenditures made only once or twice a year, such as auto or home insurance premiums or yearly car tune-ups. In those cases, you simply figure the total paid for the year, divide by 12, and add that number to the monthly figure.
For the purposes of the 70-20-10 rule budget, living expenses also include discretionary spending on things like shopping, entertainment, travel and other non-essential items.
To get started, scan through a couple of months of your bank statements, credit card, utility, medical, housing, insurance, and cable and internet bills to see how you’re tracking. Use the common living expenses listed below as a guide. You’ll be able to determine how much you’re spending on living expenses and whether it exceeds 70% of your available income.
• Car payments
• Gas and tolls
• Public transportation costs
• Taxis and ride shares
• Auto insurance
• Day care
• After school programs
• College tuition
• Health insurance premiums (if not deducted from your paycheck)
• Auto and home insurance premiums
• Life insurance premiums
• Disability income insurance premiums
• Takeout and restaurants
• Deductibles, copays and coinsurance
• Prescription drug costs
• Over-the-counter drugs
• Eyeglasses and contacts
• Concert, theater, and movie tickets
• Paid streaming and podcast services
• Flea and tick prevention/other medications
• Vet bills
• Pet insurance
• Hair care and other grooming
• Gym membership
If your monthly number hits the 70% mark or less, congratulations. You’re living within your means. For most people, however, this first calculation will likely exceed 70%. More on what to do when that happens below. For now, let’s keep looking at the big picture of tallying your 70-20-10 numbers.
20% for Saving
Next, you want to calculate how much it will take to hit the 20% goal of saving and debt repayment. (If you don’t have debt, hooray; you can zoom straight to saving. But many of us need to use this bucket to pay off debt and save.) In terms of calculations, let’s say your monthly income after taxes is $2,500. Divide by five to get your 20% figure: You’ll need to shoot for saving $500 a month.
If you have credit card debt, you’ll likely want to focus all or part of this 20% on paying that down so you can avoid the high interest payments. If you have college debt, the monthly repayment amount should be included here in the 20% category.
Once that’s done, you’ve cleared the decks for other savings, whether for an emergency fund (aim for three to six months of expenses) or a near-term goal such as a vacation or down payment for a home.
Depending on what and why you are saving, different kinds of savings accounts may make sense. There’s always the traditional savings account at a bricks and mortar bank, but consider these smart options to get extra benefits:
• High-yield savings accounts make sense if you need your money liquid (accessible) but want to earn more interest than the current rate on traditional savings accounts. And who wouldn’t? A high-yield account won’t earn you double digits of interest, but it should get you out of that fraction-of-a-point place that many traditional accounts are sitting in. And they’re FDIC-insured. This can be a great place to put emergency funds, money that’s growing towards an upcoming goal (like a big vacay), and the like.
• A certificate of deposit (CD) is another option. These accounts lock up your money at a specific interest rate for a period of time, usually from six months to a few years. What’s nice is you know how much money your money will earn, but keep in mind, if you pull your money out early, you’ll face penalty fees.
• Money market accounts (MMAs) combine some aspects of a savings account with features of a checking account. You’ll earn interest on your savings (possibly in the ballpark of high-yield accounts), and you may be able to access funds via debit card or checks.
Once you’ve taken a look at your savings/debt picture, you’ll determine how best to handle the 20% rule. Depending on the size of your debts and your living expenses, you may need to temporarily allocate more or less funds to this category. More on that below.
Recommended: How Do Savings Account Work?
10% for Donation
While the final 10% of this plan is typically earmarked as for “donations,” let’s be clear: The beneficiary of those donations may well be you! The remaining 10% can be allocated to investing in your future, usually for retirement. Contributions to an IRA, 401(k) 403(b), self-employed retirement savings vehicles, or other long-term, tax advantaged savings plan can be best for this category. This is money that you won’t need in the short term, so it can be invested more aggressively than the savings in your 20% category.
In addition, part of this allocation can go to donations and other charitable giving that you want to make part of your budget. Perhaps there’s a cause you want to support, from animal rescue to medical research, or you like to donate to your college; it’s your call.
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Tips for Following the 70-20-10 Rule
The beauty of the 70-20-10 plan is its simplicity — and flexibility. You can customize the allocations within reason to meet your own needs and financial goals over time. Creating a budget can give you peace of mind, because you’ll know you are taking care of your financial health. So let’s get going. Here, a few tips for increasing your likelihood of success in following this plan:
Use After-Tax Income
When allocating your monthly income to the various percentages, you want to work with after-tax income, or the money that’s actually available to you, instead of your gross salary. This is important, otherwise you will be working with your pre-tax or gross income, and the numbers won’t track properly.
Worth noting: Bonuses, tax refunds, money from side gigs and other income should be factored in later, as they are earned; don’t consider them as part of your base income. The bulk of the extra income can be designated toward the area most in need of attention, such as paying off credit card debt or boosting emergency savings. But do feel free to set aside a small percentage of those earnings as a reward for your hard work and have some fun with it.
Like any budget, the 70-20-10 plan works best if you take a bit of time to track your spending over a month or two. Don’t just put it in place and feel you are bound to follow it forever. This success secret will allow you to see what you’re spending for essentials and where discretionary dollars are going. This, in turn, can help pinpoint areas that could be reduced or increased. Budgeting apps such as SoFi Relay can help simplify the tracking and budgeting process.
Adjust the Percentages When Needed
After tracking your spending and making possible cuts, you may find you still can’t fit living expenses into the 70% category. Don’t stress out over this! If you have limited funds and lots of bills, you may have to allocate a bit more to that category and put less in short-term savings until that next raise or other income spurt comes through.
A quick note for people with lots of credit card debt: Those hefty bills are a sign that you may be spending more than your income level allows. You’ll probably do better with the 70-20-10 budget if you increase the paying debt/savings percentage to higher than 20% till your debt is lower. Take steps to reduce discretionary spending, perhaps even more than you have already. For example, cutting back on take out and restaurant meals, streaming services, and clothing purchases can all add up to more savings quickly. This bit of belt-tightening is also a good way to keep debt from getting out of hand as you go forward.
In addition, you may find you need to make more drastic cost-cutting moves too, such as finding an apartment with less expensive rent or ditching the expensive car payments and switching to mass transit. The goal is to get costly debt under control so you can start saving for your priorities and peace of mind.
Whenever you find the need to adjust percentages, it may be best to avoid tampering with the 10% investing for the future allocation. The sooner you start saving for retirement, the more that money will add up over time. By the same token, older people who may need to catch up on retirement savings may want to increase this 10% allocation. One of the reasons the 70-20-10 plan can be successful is that it helps you balance both short-term needs with long-term financial planning.
If you do make percentage adjustments, be sure to continue to track expenses so you can see when you can readjust allocations back to the original 70-20-10 plan.
Make the Most of Your Saving Allocation
Where you put your 20% savings can help you reach your goals. High-yield savings accounts, money market funds, certificates of deposit (CD), and cash management accounts are all vehicles that may pay more interest than a traditional savings account, helping your savings grow.
Ta-da! You’re now ready to try the 70-20-10 formula. By allocating your available income into three distinct categories, you can take steps toward achieving your financial goals, now and into the future. Sure, the mere mention of this kind of budgeting can make many of us cringe. But with this simple plan, you can likely clean up your financial act and feel less stressed about money. Which are very good things to work toward.
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