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Moumi
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.
