Budgeting: How to Use The 70-20-10 Rule

When I started my first job after college I had no idea what the 70-20-10 rule was or how to save money for my future. I worked as a part-time employee for a non-profit. They had no retirement plan nor any options for me to pay into an individual retirement account. I knew nothing about investing or the stock market or about ways I could start saving for my future.

To be honest, I wasn’t even thinking about retirement back then. I was focused on finding a full-time position that offered good pay and a positive long term employment outlook. If only I knew then what I know now, I would have started budgeting and saving even a small portion of my income.

The Rule

Now I know that successful saving for the future must include not only budgeting your income, but saving a portion, as well. And it doesn’t matter how much money you bring home each time you are paid. One budgeting formula that is popular with many in the financial independence community is The 70-20-10 Rule for budgeting and saving.

The 70-20-10 Rule is a saving strategy that helps with short or long term savings goals, emergencies, and retirement. The Rule divides your income into three categories: living expenses, savings and debt payments.Following this rule begins with your understanding of how you spend your money each time you get paid.

The 70%

By the way, having a budget really helps with this part of the plan. Do you pay rent or have a mortgage? How much do you spend on food and clothing (do you need uniforms or special clothing for your work?). Do you drive to work each day? How much do you pay for gas? All of these living expenses should not exceed 70% of your income. You might also want to include discretionary spending in this category, such as eating out or entertainment. Consider also including giving in this category such as to your church or another charity or non-profit.

Remember that you might not need to allocate 70% of your money for living expenses. Lowering you rent by having a roommate is one option. Or taking public transportation to work each day to save on transportation expenses. You can also limit how much you spend on eating our or buying clothes that you can do without. If you have debts that you need to pay, lower living expenses is one way to send extra funds to your debts to pay them off faster.

crop payroll clerk counting money while sitting at table

The 20%

The next part of the 70-20-10 rule allocates 20% of your income for savings. One way to do this is by dividing your 20% like this:

  • 10% would be contributions to your retirement account held in an account like a 401(k), 403(b), a brokerage investment account or a Roth or Individual Retirement Account (IRA);
  • 5% would be for emergencies like an unexpected car repair or medical bill or even sudden lay off from your job;
  • The final 5% of your savings would be for a special short or long terms goals you set for your money. Maybe you want to save for college tuition or a spring break vacation or new technology that you want to get for yourself.

Of course, you could choose to divide this 20% portion of your money differently. For example, you could allocate 8% for retirement savings and 12% for emergencies. To stay consistent with your savings, put your 20% directly into your bank savings account.

Remember to always pay yourself first. I didn’t start to seriously save for my retirement until I was in my early 30’s. I had already lost 10 years of potential savings and the interest that would have come with it. The late start meant that I had to save more over a shorter period of time to reach financial independence.

The 10%

The final part of the Rule allots 10% of your take home pay to paying any debts you have. This might be student loan debt, credit card or consumer debt, car payments or a personal loan you need to repay. The lower your debt payments, the more you can save for your goals or retirement. Your goal should be to eliminate all debt payments as soon as possible. That means you might want to designate more than 10% to debt payoff – especially if the debt comes with a high interest rate.

Once I paid off all of my consumer debt, I never wanted to be into a situation where I owed money for the stuff I bought. As a result, I have remained consumer debt free for years. Instead, I use the money I save for vacations, gifting to charities and helping to pay for my child’s education.

Make The Rule Work For You

The 70-20-10 Rule of money management is only a guide. Don’t feel pressured to follow this outline if it doesn’t quite work for you. Remember, this rule is only a template to get you started on the road to financial independence and retirement success. If you don’t have debt you can allocate an additional 10% to retirement savings through an investment account. Eliminating or reducing debt frees up money to use elsewhere.

Another option for modifying the plan is to change the lower the percentage you spend on living expenses. Maybe you can choose to stay at home with your parents for a few years after graduation and save the money you would have spent on rent. Or you might decide to eliminate or drastically reduce your clothing budget. There are lots of ways you can lower your living expenses and reallocate the money to your savings for retirement or to help fund your goals.

Whatever your final allocations might look like, the key to success is to just get going. Set up your automatic savings deposits and start tracking your expenses with a budget. Saving early and consistently is the key to future success!

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