When it comes to making financial progress, we can all agree that saving for the future is a critical part of the equation. But how much are you supposed to be socking away exactly?
According to the 50/20/30 rule, your monthly budget should be divided into three distinct categories of expenses: 50 percent should be reserved for essentials (think housing and food), 30 percent should be allocated for lifestyle choices (things like nights out and 121 channels of cable) … and at least 20 percent should go toward what we call “financial priorities,” which include debt payments, retirement contributions and, of course, savings.
Since these percentages are divisions of your net pay — the after-tax income that you bring home — someone who makes, say, $35,000 a year should set aside at least about $4,800 for financial priorities.
Think that sounds like kind of a lot? You aren’t alone.
That’s why we spoke to LearnVest Planning Services CFP® Tonya Oliver-Boston to find out if wereally need to allocate 20 percent of our income toward financial priorities each year — and how much of that 20 percent should go into savings.
Why anyone can (and should!) follow the 20 percent rule
For many people, putting at least 20 percent of their net pay toward financial priorities isn’t actually all that difficult. In fact, Oliver-Boston finds that the biggest problem clients generally face isn’t that they can’t manage to allocate the 20 percent for financial priorities — rather, it’s that outsized debt, like student loans and high credit card balances, that eats up most of that 20 percent, leaving little left over for savings. But as Oliver-Boston cautions: “Even if you have debt in excess of 20 percent of your net income, you still need to find a way to save!”
Translation: Prioritizing one financial priority doesn’t mean that you can ignore the others — be it debt payments, adding to your emergency fund, contributing to your retirement, or other savings goals, like accruing enough money for a down payment on a house.
So what’s the best way to divvy up that 20 percent across all of your financial priorities? “It depends on the individual situation,” says Oliver-Boston. “But emergency savings and payments on high-interest debt tend to fight for first priority.” Retirement, she adds, is usually a strong third because it’s critical for your long-term financial health, followed by other savings goals, like that down payment we mentioned.
Need real-life examples? According to Oliver-Boston, if a client has a lot of high-interest debt but also has emergency savings, the client’s first priority would most likely be the debt because she has money in place to support her should she find herself in a situation in which her income could no longer cover her living expenses. If a client is cash-strapped, however, putting money into an emergency fund would probably take priority because the client doesn’t have the necessary cushion to cover her day-to-day expenses should an emergency arise.
Think you can’t save enough? Think again
In most cases, it’s unlikely that you simply don’t have the money to put toward your financial priorities. It’s more likely, explains Oliver-Boston, that you’re devoting too much of your income to another category of spending.
For instance, if your essential expenses are in excess of 50 percent, there’s a good chance that the culprit is a rent or mortgage payment that’s too high for your income. There’s good news and bad news here: On the bright side, you can quickly free up a lot of money. On the not-so-bright side, you’ll have to make a big change to do it … like a move.
“It’s a sticky situation,” says Oliver-Boston, “because you can’t make a client move. But when it’s pointed out to you that the troublesome element of your budget is a fixed percentage, it shouldn’t be surprising that you don’t feel like you’re getting ahead.”