Implementing a savings rule to your budgeting can help you optimize your finances in the long run. Our role as financial advocates and partners is to help clients find which rules and plans work best with their personal finances and goals. In this blog, we’ll teach you about the 20/20/60 savings rule and why it could work for you.
Before We Jump Into the 20/20/60 Savings Rule…
It’s good to talk about other well-established or popular rules that you may have heard of. The 10/20/70 rule is one of these rules in which income is allocated among three categories:
- 10% for savings
- 20% for consumer debt
- 70% for living expenses
The drawback with this savings rule is that it can become too moderate once you earn a substantial income.
The 20/20/60 Rule Explained
Given the above drawback, we believe using the 20/20/60 savings rule is better for high earners who have more financial freedom. To start, the 20/20/60 rule uses the same three categories as the above rule with some percentage adjustments:
- 20% for savings
- 20% for consumer debt
- 60% for living expenses
In order to transition to this rule, it’s important to note that as you increase your savings rate to 20%, you should prioritize the following:
Emergency funds
The rule for emergency funds is to have 3 to 6 months’ worth of living expenses in cash. As a high earner, it is better to save for the 6-month contingency. In the event of a misfortune, such as a job loss or health problem, this money will be necessary.
Contribute the maximum to retirement accounts
Now that you are able to afford putting more towards your retirement, it is a good idea to take advantage of these accounts. Contributions are deductible, which will lower your tax burden. Also, if you have a 401(k) or a similar employer-sponsored plan, you may have matching, which is extra money put forth by your company towards your retirement at no cost to you.
Build other accounts
With income to spare, you can save it in other avenues. One option would be a Roth IRA, a great retirement account that you can contribute after-tax money towards, and withdraw from tax-free during retirement. Or, you can invest in a brokerage account to grow excess funds that you have no current use for.
Apply This Savings Rule to Your Finances
Assuming that you are already following the 10/20/70 rule, you should already have a working budget, control over debt, and have begun saving money. You should be using average after-tax monthly income to make these calculations.
If you are a high earner, chances are that you are already spending less than 60% of your income on living expenses. If so, your main goal is to not let your expenses catch up to more than 60%. If not, you should look at your monthly budget, and determine what items can be cut down.
As you can tell by the percentages, the purpose of switching to a 20/20/60 savings rule is to save money and build wealth more aggressively.
