We often hear 80-20 rule when it comes to savings, and a lot of 'experts' in the field confer to it. However, in this article, we'll try to understand if 80-20 really works for you.
What is the 80-20 savings rule?
As a refresher, this rule or principle tells us that once we receive any particular inflow (i.e. salary or business income), we immediately carve out the 20% and keep it in your savings account. This way, you are forced to spend only 80% for your needs (even wants).
To whom does the 80-20 savings rule apply?
The 80-20 savings rule only works for those with excesses which we define as the surplus from income once you take out your non-discretionary expenses. In here, we define non-discretionary expenses as your strict needs, spending that you cannot or very difficult to avoid within a short time frame. Examples include utility bills, rent, tuition fees and etc. Hence, you may want to analyze your expenses first and identify which are discretionary (commonly your wants) and which are non-discretionary.
Chances are, you'll be surprised that a huge chunk of your expenses could just be discretionary. Hence, if such is the case, you can opt to apply this rule for you. Otherwise, you can't force this rule (and it will not work). You'll end up giving yourself unnecessary stress. In fact, what you may want to focus on is expanding your income streams. More details are shared in the podcast episode.
Why 80-20 rule can be limiting
While I'm not dismissing the fact that the 80-20 rule works for some, I want to highlight that it can also be limiting. This happens especially for those who are choosing 80-20 rule just for the convenience. If this rings a bell, then you may want to stretch your financial maturity a bit by really analyzing your expense, because you might be missing out on the chance of having a savings rate higher than the 20%, which in turn slows down your progress in hitting your saving goal or dream investments (such as real estate, etc.). Hence, you can do is really sit down on your expenses, categorize them into discretionary and non-discretionary. Then, estimate your should-be savings rate which can be done by deducting the non-discretionary expenses from your income, and divide the difference by your income. Let's look at the sample below:
In the example, we take into account a reward for yourself, because you don't want to fully deprive yourself of the joy from your hard work. In this example, we get to realize that we can cut short the time to reach our target savings by breaking down our expenses rather than just relying on the 80-20 rule.
If there's something that I want you to practice out of the 80-20 rule, that is the commitment of setting aside the money immediately after receiving inflows. However, we now modify this to the savings rate you determined through your analysis. Hence, if we follow our example, instead of setting aside 20% during pay day, you begin setting aside 32% instead. This way, you'll hit your targets faster.
Listen to this episode in the podcast
A lot will be further expounded in this episode, so hit the play button now.
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