Tuesday, 24 December 2013

Watch Your Savings Grow With the 80 - 20 Rule

Saving money is an important part of personal financial management. The other part of the equation is to keep your spending under check. With that in mind, there is a way to simplify personal financial management by following a rule of thumb simply called the 80 - 20 rule.

The rules say to put away 20% of your income and save it somewhere with the remaining 80% used to pay for necessities and other discretionary items. It is an uncomplicated way to budget and this puts a portion of your income into savings.

Paula Pant derived the idea for the 80 - 20 rule from Harvard bankruptcy expert Elizabeth Warren and her daughter Amelia Warren Tyagi. The mother and daughter team discussed the 50 - 30 - 20 plan in their book All Your worth: The Ultimate Lifetime Money Plan.”

Under Warren and Tyagi’s plan, you will need to allocate 50% of your after-tax income to pay off the necessary things in your life like groceries and housing or your “needs”. The other 30% can be spent on “wants” or discretionary items. The remaining 20% must be put towards savings and debt repayments.

Manage Your Spending with the 80 - 20 Rule

With the 80 - 20 rule, it is easier to budget because it frees you from the complication of differentiating your “needs” from your “wants.” This is great because the line between these two types of spending is not always clear. This is not to say of course, that your spending will fit nicely into the 80 - 20 rule and that your expenses only amount to 80% of your after-tax income.

You will need to sit down and look at your spending. It can be as simple as writing down your spending for the month on a notebook and looking at how much of these you absolute need. You might be surprised to find that much of your spending goes towards unnecessary things like entertainment expenses or for new gadgets that you might not really need. If you find that your “needs” still exceed the 80% threshold, then you might need to review those “needs” or start taking steps to further cut these down.

Grow Your Savings with the 80 - 20 Rule

Once you review your spending and find out how much of it would fall under the “needs” category like groceries, housing, and utility bills, you can find out if you the safe and consistent way to put 20% of your after-tax income into savings. You could open a savings account and put in 20% of your income into this account. After it grows a little and you find that you don’t touch this money, you could consider transferring your savings into a time deposit account to help you earn more. If you continue to roll your time deposit account into a new term, you could watch your savings grow through the power of compound interest.

The 80 - 20 Rule is just a rule of thumb and it’s useless if you don’t take steps to follow the principle. It simplifies budgeting and it works if you know how to save and if you have the will to make it work. If your office allows you to automate savings by putting 20% of your income directly into a savings account, then take advantage of that. You won’t miss the money and before you know it, you’re savings have grown immensely.


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