Saving & Investing: A Frame of Reference for Thinking About How Much to Save (10th Blog Post)

In our 8th blog post (“Budgeting & Spending: A Frame of Reference for Thinking About How Much to Budget and Spend on Individual Spending Categories”), we referred to two sets of broad budgeting guidelines personal finance experts commonly recommend. The first is what is referred to as the “50/30/20 budget rule”. The 50/30/20 budget rule is a set of broad guidelines involving the following recommended personal / household budget allocation:

(Take-home income represents your income after income taxes and other items have been “deducted” --i.e., “withheld” or subtracted -- from one’s paychecks.)

The second is what is referred to as the “70/20/10 budget rule”. The 70/20/10 budget rule is a set of broad guidelines involving the following recommended personal / household budget allocation:

(Take-home income represents your income after income taxes and other items have been “deducted” --i.e., “withheld” or subtracted -- from one’s paychecks.)

(As a reminder, the numbers in the two charts above represent spending targets as a percentage of one’s take-home income, NOT as a percentage of one’s gross income. Gross income represents one’s income BEFORE income taxes and other items have been “deducted” -- i.e., “withheld” or subtracted -- from one’s paychecks. Take-home income represents one’s income AFTER income taxes and other items have been “deducted” -- i.e., “withheld” or subtracted -- from one’s paychecks.[1])

You will notice that there is a savings component in both sets of budgeting guidelines, which to be clear a) involve targets and b) are a frame of reference or broad conceptual framework (as distinguished from a “hard” set of rules or a one-size-fits-all prescription) that you eventually would adjust in practice based on your unique personal circumstances. So, as these guidelines relate to specifically savings, if as an adult you earn just enough to “pay the bills”, then saving 10% or 20% of your income simply may not be possible. On the other hand, if you are able to set aside 10% or 20%, or even more, of your income as savings, then the benefits potentially can be significant. All else equal:

1. You will increase your financial flexibility in the future;

2. You will create greater financial stability in your life because you suddenly have greater flexibility to cover unexpected expenses that you may encounter; and

3. You will increase your probability of being able to eventually fund those expenses in life that tend to be relatively larger (such as buying a home, buying a car, helping to support a family, going away on vacations, helping fund a college education, starting a business, having a comfortable retirement, etc.), that is if you want to.

I would love to hear from you. Any ideas, experiences, thoughts, comments and questions….please do share.

[1] Employers commonly “withhold” (i.e., “deduct” or subtract) a portion of their employees’ pay in order to cover on their employee’s behalf what are called Federal “payroll taxes” (“payroll taxes” are used to fund Medicare and Social Security, both of which are large US government spending programs) as well as Federal, State and perhaps local income taxes. Employers are required to do this. It is also not uncommon for employers who provide health insurance and/or retirement benefits to their employees to “withhold” (i.e., “deduct” or subtract) from their employee’s paychecks a portion of their pay to partially cover the costs of these benefits.

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