The 80/20 Approach
The 80/20 approach to saving simplifies the entire process of saving. Instead of tracking every single expense, simply allocate the first 20 percent of your take home pay to savings and long term planning. Then you can use the remainder of your money as you wish. Obviously it is best to track all of your expenditures, but if budgeting is just a non starter for you, this may be your next best option.
Using Your 20 Percent
Now that you have the money to put towards saving and long time finances, let’s take a look at where you should put it.
High Interest Debt
Before you start saving for retirement, you need to tackle the anchor around your neck, high interest financing. In general, this means credit card debt. With average credit card interest rates above 17 percent, this can amount to thousands of wasted dollars every year. Wasted dollars that would be of much better use in a savings or investment account.
Eliminating credit card debt can be a challenge however, which is why you need a plan. Here are the two most common examples.
Debt Snowball Technique
If you need motivation, this may be the debt reduction method for you.
With this method, you simply organize your credit cards by balance. You then pay the minimum on all credit cards except the one with the lowest balance. On this card, you pay as much as you can. Once you pay it off, you then move to the next lowest balance.
The idea behind this method is that, by attacking the lowest balance card, you will pay off a card quickly. That motivates you to move on to another card and repeat the process.
Debt Avalanche Technique
For those of you who are more logic based, this plan will appeal to you.
With this method, you organize your credit cards by interest rate. You then pay the minimum on all cards except the one with the highest interest. On this card, you pay as much as you can until it is paid off. Then, you move on to the next highest interest rate card.
This method allows you to make the most of your money by eliminating the highest interest debt first.
Once you have the credit card debt handled, you need to move on to your emergency savings. But how much do you need?
A good rule of thumb is to save 3 to 6 months worth of expenses. This will protect you in most cases from financial emergencies. If your take home money is 4000 dollars, you would therefore need to save 12,000 to 24,000 dollars. A tidy sum, but now that your savings rate is 20 percent of your take home pay, is will take less time than you think. 15 to 30 months if you are devoting your entire 20 percent to emergency savings.
With a well stocked emergency savings, your next goal will be to build your retirement savings. If you have a company sponsored 401K, you should already be maxing it out. If not, make the changes needed to do so.
Beyond this, the investment opportunities are endless and can range from conservative to risky. For best results, if you do not have a financial background, seek the help of a qualified financial advisor.
Vacations & Major Purchases
A small amount of your 20 percent should go towards major purchases and vacations. Without this type of fund, you will likely put these expenses on credit and that can lead to building up that high interest debt that you worked so hard to pay down.
The amount you put into this fund is quite simple to estimate. Add the cost of your anticipated vacation/vacations and major expenses and divide by 12. So, if you plan to take a vacation that costs 3000 dollars, plan on saving 250 dollars a month for it.
Obviously, it would be much better to track all of your expenses, but you may just be one of those people who never get into budgeting. If this is the case, give the 80/20 method a try. The most important thing after all is that you save money and build wealth.