The 70/20/10 budget rule is a financial planning tool that helps you live within your means, save and pay down debt. It is a common proportional budget method.
Elizabeth Warren popularized proportional budgets with the 50/30/20 rule. The idea is that you should spend 50% of your income on needs like housing food, and bills, the next 30% on wants, and the last 20% on savings or debt repayment.
Proportional budgeting rules are based on your take-home pay. So if you are paid $3000/mo and after taxes, you take home $2000 – you’ll base your budget on $2000.
Proportional budgets are effective at boosting your savings rate because they place a direct focus on saving. They’re also simple to understand and comprehend. This makes it easier to stick to.
For a lot of people, myself included, the 50/30/20 rule is unrealistic. Especially if living in an area with a high cost of living like New York or San Francisco. This is where the 70/20/10 budget comes in.
The 70/20/10 budget rule
With the 70/20/10 budget rule, 70% should account for your living expenses and wants 20% for savings, and 10% for debt payments.
It has a couple of benefits over the 50/30/20 rule.
First, it allows for more flexibility because living expenses and wants are combined into a single category. So you can break up this 70% any way you’d like.
Because of this, you’ll be able to budget more effectively in a higher cost of living area. For example, if you’d like to rent a nicer place you can take a larger portion of your living expenses, thus reducing the amount you have for wants.
Now, what exactly does each category include? Let’s take a look and then see how to use the 70/30/10 rule.
Living expenses
Using the 70/20/10 rule, you’ll allocate 70% of your income to living expenses and wants. Living expenses include your rent or mortgage payment, bills, food, gas for your car, fun money, etc. Fun money can be thought of as your discretionary spending. So, things like clothing, dining out, etc.
As I said, you’re more in control of your spending with this budgeting method compared with the 50/30/20 rule. Just be aware that 70% of your income should include everything between the first of the month and the last of the month.
Savings
20% of your income should be put toward your savings goals. This should account for all of your savings goals. That means you’ll need to divide it between your long-term savings like retirement and your short-term savings like a downpayment for a house.
What works best for me is to divide my savings into two perfectly equal parts. In this case, 10% would go to retirement and 10% would go to another savings goal. If you don’t have an emergency fund, I recommend that you set building an emergency fund as your other savings priority.
For those that don’t know what an emergency fund is, it is a savings account that you keep on hand for emergencies. It should be between 3 and 12 months of your living expenses. So, 70% of your after-tax income times the number of months you’ll feel comfortable with.
Debt payments
Finally, if you have any debt, 10% of your income should go toward paying this down. Like with savings, this 10% should be divided among all of your debts.
As you probably know, all debt isn’t created equal. This means you should target, and pay down the debt with the highest interest rate first. Things that fall into this category tend to be short-term debt like credit card debt or payday loans.
If you are debt-free, then I suggest using this last 10% to invest with. This would be in addition to any investments you’re making with your savings. A couple of great examples are saving for a wedding or start your child’s college fund. You could also use it to invest in speculative investments like cryptocurrency or more speculative stocks.
How to use the 70/20/10 rule
Using the 70/20/10 budget rule can be broken down into three simple steps. Determining your take-home pay, allocating your income, and tracking your progress.
Step 1: Determine your take-home pay
The first step to using the 70/20/10 budget rule is to determine your take-home pay. Are you paid every two weeks? If so, there are a couple of things you can do.
What I like doing, in this case, is calculating my monthly income as two paychecks. That leaves two more paychecks per year that are unaccounted for. I tend to deposit these two extra checks directly into my savings. Though, you can use them for whatever you want. From rewarding yourself with a vacation to turbocharging your savings rate and anything in between.
The other option is to multiply your paycheck by 26 and divide by 12. I find this method is more difficult since you have to track your bank account closer and cut into other paychecks.
Step 2: Allocate your income
Now that you know your income, you’ve gotta break it down for each category – living expenses: 70%, savings: 20%, and debt payments: 10%. Let’s look at an example of how this works.
Assume that my take-home pay is $2000/mo. 70% of this is $1400 and would be for living expenses, 20% ($400) for saving, and 10% ($200) for debt repayment.
Living expenses:
Rent is most likely the largest living expense, so let’s subtract it from living expenses ($1400) to see what’s available for the remaining expenses.
In this example, let’s assume rent is $700. That leaves $700 for bills, transportation, food, fun, wants, and other living expenses. This is my list of expenses:
- Rent $700
- Utilities (gas, water, internet, phone) $200
- Transportation $200
- Food $200
- Fun $100
Savings:
This category depends on your goals. I want to save 10% of my income for retirement and save 10% of my income to build a 6-month emergency fund. My living expenses are $1400. So a 6-month emergency fund should be $8400. This leaves us with:
- Retirement $200
- Emergency fund $200
Debt payments:
I have student loans and credit card debt. I have a minimum payment that I need to make for both my student loans and my credit card.
Because the interest rate on my credit card is 20% and my student loan interest rate is only 5%, I will prioritize paying my credit card off. I will make the minimum payment on my student loans, and throw any extra money at my credit card payment. This looks like this:
- Student loans $120
- Credit card debt $80
Step 3: Track, analyze, and optimize your spending
The most common issue people have is the adjustment to living on just 70% of their take-home pay. This tends to work itself out after a couple of months. It takes effort to track and analyze your expenses.
Areas for improvement could be as simple as switching from an unlimited phone plan to one where you pay for what you use. This alone can easily save $50/mo. It could also be as difficult as moving into a cheaper apartment when your current lease ends.
It is important to continuously monitor your spending and tweak it. Eventually, you’ll get to a point where you hit living on 70% of your income without trying or feeling like you’re making a sacrifice.
When to not use the 70/20/10 rule
You shouldn’t use the 70/20/10 budget rule if you have a lot of debt. This is because this particular method doesn’t allocate much for debt payments. You should choose a method that allocates a higher portion of your income to debt payments in this case.