When it comes to maintaining personal finances, it’s easy to get overwhelmed.
With at least one checking, savings, and investment account on your roster, it can seem impossible to properly manage them all.
That’s why we’re introducing the tried and true spending formula to help you structure your finances: the 60/20/10 rule.
Confused about the unaccounted 10%? Don’t worry; we’ll explain below!
While it’s more of a suggestion than scripture, this formula is a great place to start structuring your accounts. Better yet, it’s designed to be customized to meet your unique financial needs.
But first, let’s start by building a manageable (and repeatable) monthly budget:
1. Build a Budget
In the 60/20/10 rule, the 60 represents your essential expenses, like your monthly rent, utilities, credit card payments, and money sent home.
In other words, 60% of your monthly income goes directly to covering these necessities.
But how can you possibly be so precise with your money? Simply build a budget with these three easy steps:
1) Calculate your monthly income: This is the most important step in all of your planning. By identifying how much you earn each month (after taxes), you’ll be able to plan ahead.
2) Track spending patterns: There are two ways to get a sense of your spending patterns. For starters, you can look back at your expenses over the last few months, add everything up, then determine your monthly average.
Conversely, you can start monitoring your spending patterns over the coming months with convenient apps like Mint and You Need a Budget (YNAB).
P.S. Don’t forget annual expenses like property taxes, car insurance payments, and doctor’s appointments.
3) Define your priorities: Once you start tracking your spending, it becomes a lot easier to separate essential and non-essential expenses. By defining your priorities, you’ll be able to figure out what areas of your life get the first 60% of your monthly income.
And if you find that your monthly expenses are closer to 70% or higher, that’s okay, too. It’s more important that you can identify your spending habits, create a budget, and reliably stick to it.
That covers the first part of the 60/20/10 rule. What about the 20?
2. The Secret to Saving
We won’t bury the lede. The secret to saving is to automate it.
How else can one have the resolve to put away as much as 20% of earnings in a savings account?
By automating your savings, you effectively “pay yourself first.” After all, saving money doesn’t spontaneously happen. It’s the result of discipline and foresight.
Here are three great ways to automate your savings:
- Enroll in your employer’s retirement plan, especially if they match your contributions.
- If your job doesn’t offer a retirement plan, you can still save money every paycheck. Just set up an automatic, recurring transfer between your checking and savings account. If you’re paid by direct deposit, you can also ask for a percentage of each paycheck to deposit into savings.
- Use “round-up” apps like Acorn, which take your spare change from purchases and automatically deposit them into your savings account. While these apps may seem insignificant, they can work wonders over longer periods of time.
Though 20% may seem like a large amount of money to stash away each month, it’s the universally recommended amount to meet long term savings goals.
Furthermore, if you’re intent on building an emergency fund while reaching your retirement goals, then 20% truly is the minimum. After all, a true emergency fund should contain at least three to six months of expenses.
So, if 60% of income goes to essentials, and 20% goes straight to savings, where does the next 10% go?
3. The Stock Market
The final 10% should get invested.
According to the U.S. Census Bureau, the median household income is about $69,000.
10% of that is $6,900, or about $575 a month. If you invested that amount every month for 30 years at an annual return of about 11%, your money would reach about $1.3 million.
That’s the power of compound interest.
According to Albert Einstein, “Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn’t, pays it.”
No matter what your current income levels are, investing at least 10% is the #1 to pay yourself first. The more money you put in the stock market, the more you stand to earn.
To use our example, if you invested 15% of a $69,000 salary over 30 years (at the same annual return of 11%), you would earn nearly $2 million for retirement.
To recap the 60/20/10 rule,
60% goes to immediate expenses.
20% goes straight to savings.
10% goes to work in the market.
That only adds up to 90%! What about the last 10%?
We’re glad you asked.
That last chunk of change is for your discretionary spending — i.e., anything that you want but don’t necessarily need. This is the money you can set aside for a weekend trip, movie tickets, or a night out at the new restaurant in town.
You have to enjoy your life, after all. And because you’ve saved and invested the rest of your money, you’ll truly enjoy spending the remaining 10%.
While most rules are meant to be broken, the 60/20/10 formula is built to be customized.
Though it’s a great starting point, take liberties to tailor the formula for your specific income level, lifestyle needs, and long-term goals.
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