Are expenses taking a big bite of your income? How to save more with 70-20-10 rule
Now widely accepted as a realistic budget, will it work across different incomes?
Dubai: When budgeting, once you have evaluated how much you spend every month on living expenses, rent, paying off debt and retirement savings, what do you do next?
In particlar, what do you do when expenses often eat up most of your income? You can manage your spending using the 70-20-10 rule – which is now turning out to be an increasingly popular, intuitive and simple way to break down your budget.
There are looser variations to this rule, like the 80-20 rule, in which you use 20 per cent of your income for savings and debt, while spending 80 per cent on everything else, however, financial planners say the 70-20-10 rule has been more widely adopted than others.
How do you apply 70-20-10 rule to your budget?
The first thing you must do is calculate how much money you can allocate to your needs, wants, and savings or debt. Let’s say you’ve calculated your income as Dh10,000 per month. In this case, you’d have Dh7,000 for expenses, Dh2,000 for savings, and Dh1,000 for debt.
Now that you know how much you can spend in each category using the 70-20-10 rule budget, the question is which expenses go in each category. With some discretion in determining what fits into each category, here are some general guidelines to follow.
Setting apart 70 per cent of income for ‘needs’
What can be considered as ‘needs’? Needs are expenses that you must keep in your budget no matter what. These include things like housing, utilities, transportation and health care expenses; at least the minimum payments on your debts; and the bare minimum of basic clothing and supplies for living.
“Essentially, setting aside 70 per cent of your monthly income on living expenses or ‘needs’ are those bills that you absolutely must pay and are the things necessary for survival,” said Dubai-based wealth advisor Mohammad Shaan.
“‘Needs’, for most households, include rent or home loan payments, car payments, groceries, insurance, health care, minimum debt payment, and utilities. These are your "must-haves”. The ‘needs’ category does not include items that are extras, such as leisure activities or dining out.
“More than half of your salary or income should always be all that you need to cover your needs and obligations. If you are spending more than that on your needs, you will have to either cut down on ‘wants’ or try to downsize your lifestyle, perhaps to a smaller home or more modest car.”
More than half of your salary or income should always be all that you need to cover your needs and obligations
Setting apart 20 per cent of income for ‘wants’
What can be considered as ‘wants’? Wants are expenses that you choose to spend your money on but that you don’t need to live your life. This category includes expenses like dining out, vacations or trips, memberships, subscriptions, gifts, entertainment and other luxuries.
“Saving 20 per cent of your income is essentially setting aside money on ‘wants’, i.e. your non-essential spending. This includes going out for dinner and movies, tickets to sporting events, vacations and maybe the new tech gadget,” said Andrea Barber, an Abu Dhabi-based financial planner.
“The logic is that anything in the "wants" bucket is optional if you boil it down. You can work out at home instead of going to the gym, cook instead of eating out, or watch sports on the television instead of getting tickets to an event. Instead, you would find it more apt to save this money for a rainy day.
“This category also includes those lifestyle upgrade decisions you make, such as choosing a costlier food item instead of a less expensive one, buying a high-end vehicle instead of a more economical one, or choosing between spending money to watching television or opting for streaming entertainment.”
To put it simply, ‘wants’ are all those little extras you spend money on that make life more enjoyable and entertaining, said Shaan, adding that these can be opted to be left out in case of any emergency expenses or a sudden tightening imposed on your regular income, like a pay cut.
It’s easy to confuse many wants as needs. A simple way to determine if something is a need or a want is to ask if you could live without it. If you could, it’s a want, not a need.
Setting apart 10 per cent of income on debt-related costs
While it is often recommended that you try to allocate 10 per cent of your income to savings and investments, which includes making pension contributions to a mutual fund account, and investing in the stock market, this rule prioritises 10 per cent of your income mandatorily towards repaying debt.
“The reality for most of us is our savings category also includes debt repayment. While minimum debt payments are part of the ‘needs’ category, any extra payments reduce the principal amount and future interest owed, so they are savings,” added Shaan.
“This so-called savings or debt category is money you set aside for your future or to pay off debt faster than required. You can use this money to build an emergency fund, save for a down payment on a home, invest for retirement or pay off your education loan debt or credit card more quickly.”
While most experts recommend that you have at least three months of emergency savings on hand in case you lose your job or an unforeseen event occurs, after which, you are asked to set apart money on retirement and meeting other financial goals down the road.
However, planners also advise that if emergency funds are ever used, the first allocation of additional income should be to replenish the emergency fund account. If you want to save money more quickly, you’ll need to set aside some of your wants money for extra savings.
However, the amount of the minimum payment would instead count toward the 70 per cent needs category, added Barber. “This is because not making at least minimum payments on your debt would negatively affect credit, and for debt like credit cards, cost you additional money in the form of interest.”
Takeaway? 70-20-10 budgeting rule is increasingly popular for those with high expenses
If you’re not sure where to start with a budget, breaking it up into these basic categories can be really helpful. Those percentages help create a balance between obligations, goals and splurges.
Moreover, the 70-20-10 budgeting rule may work for those with living expenses on the higher end, said Shaan, while citing the example of someone residing in an area where the cost of living is high.
“Keep in mind that you can adjust the rule for your particular needs by changing the percentages to match your personal situation and financial goals,” he added.
An instance where the budget doesn’t necessarily work is if you’re not earning much, said Barber, when you might not have the luxury of only spending half your income on necessities. “Depending on your financial situation, you may have trouble sticking to those exact percentages,” she added.
“If you already have a major education loan debt or multiple home loans, in particular, you may find that your living expenses and the minimum payment on your loans require more than 10 per cent of your income.”
In cases like this, planners like Barber and Shaan further advise that you would need to treat the 70-20-10 rule as more of a financial goal, limiting your other spending and working towards reaching that balance.
“Keep in mind that the logical principle of the 70-20-10 rule is that you should limit your spending based on your income and always put some of your money towards repaying debt and saving for the future,” added Shaan.