When it comes to making financial progress, we can probably 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, you should consider dividing your monthly budget into three distinct categories of expenses: 50% should be reserved for essentials (think housing and food), 30% should be allocated for lifestyle choices (things like nights out and 121 channels of cable) ... and at least 20% should go toward what we call "financial priorities," which can 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 consider setting 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 we really need to allocate 20% of our income toward financial priorities each year—and how much of that 20% should go into savings.
For many people, putting at least 20% of their net pay toward financial priorities isn't actually all that difficult. In fact, Oliver-Boston finds that one of the biggest problems clients generally face isn't that they can't manage to allocate the 20% for financial priorities—rather, it's that outsized debt, like student loans and high credit card balances, that eats up most of that 20%, leaving little left over for savings. But as Oliver-Boston cautions: "Even if you have debt in excess of 20% 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% 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 can be 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%, 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 may be able to 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."
If it isn't your fixed expenses that are throwing your budget out of whack, then it's probably your lifestyle choices. This, too, is changeable. Since few things you truly need fall into this category, you should be able to eliminate lifestyle expenses fairly easily. That said, since dinners out tend to add up slower than, say, rent, it might take a while.
"It's almost like weight loss," says Oliver-Boston. "Changing your essential expenses is the equivalent of having surgery—it's immediate, so you see the change right away. But changing your discretionary spending is like losing a pound a week. It will take a bit, but you should be able to get there."
To be fair, Oliver-Boston qualifies, the people who are having trouble saving 20% aren't necessarily making unwise choices when it comes to properly allocating their money. "During the downturn, a lot of people used credit cards to get by without an understanding of how much debt is too much," she says. "And now they're getting jobs at lower pay rates, plus the student loans they deferred are now due." So although many people in this situation are working, she says, they're not making as much, so they tend to continue to use credit cards to get by. "For these people," she says, "the change they would need to make in their lifestyles to save enough money would be dramatic."
But regardless of whether your budget is a little unbalanced or you're recovering from a major financial shock, Oliver-Boston's advice for finding the funds for your financial priorities is the same. "First of all, you need to take a realistic look at your expenses, because turning a blind eye isn't helping anybody," she advises. "And, second of all, you have to be willing to change."
LearnVest Planning Services is a registered investment adviser and subsidiary of LearnVest, Inc. that provides financial plans for its clients. Information shown is for illustrative purposes only and is not intended as investment advice. Please consult a financial adviser for advice specific to your financial situation. LearnVest Planning Services and any third-parties listed, discussed, identified or otherwise appearing herein are separate and unaffiliated and are not responsible for each other’s products, services or policies.