Pay yourself first - the 80/20 budget

Range Certified Financial Planner
Range Certified Financial Planner
October 18, 2022

There are a lot of different ways to budget your money.  At Range we believe in paying yourself first by following the 80/20 rule.  This is the best way to ensure that you are saving towards your important financial goals while still covering your monthly expenses.  This philosophy focuses on automating that initial 20% so it never even hits your regular checking account.

The 80/20 rule says that you should first set aside 20% of your net income for saving and paying down debt.  Then split up the additional 80% between needs and wants.

When using the 80/20 rule, calculate the amounts based on your net income - everything leftover after you pay taxes. For example, if you earn $100,000 per year and pay roughly 20% in taxes (federal & state income and payroll taxes) you have $80,000 left to budget with. Using the 80/20 rule, you would send $16,000 to savings and have $64,000 remaining for expenses.

Using that same example, per month, you would have roughly $6,667 of income after taxes, leaving you with $5,333 for expenses after sending $1,334 to savings.

20%: Savings and Paying down debt

The 80/20 rule allots a minimum of 20% towards saving and paying down debt, depending on your situation. This includes things like:

  • saving for retirement
  • saving for an emergency fund
  • investing
  • paying off credit card debt
  • paying off student loan debt

It's essential to do what you can to find this 20% within your net income to set yourself up for success in the future. Remember, even small contributions add up over time with the power of compounding by your side.

Depending on your situation, you may be focused on paying down high interest rate debt like credit cards or personal loans before you start investing. Every situation is unique, but consider working with a CERTIFIED FINANCIAL PLANNER™ to help you find a good balance between paying off debt now and saving for the future. At the very least, most financial professionals recommend contributing enough to your retirement accounts to get your employer match, if any. That way you are taking advantage of free money to help boost your retirement savings.

And when it comes down to paying off student loans or investing for retirement, it's essential to understand the cost of debt versus the benefit of investing, while factoring in your personal feelings towards debt. There is no one size fits all, so be sure to evaluate your situation and decide how to allocate your 20% category accordingly.

One way to ensure that you are hitting your 20% category is to pay yourself first. Rather than spending and saving what's left, set up your savings or debt payoff to happen automatically as soon as you get paid. That way you increase your chances of financial success by automating your savings.  Most payroll providers will allow you to add up to 3 different accounts to split your paycheck between.  Or, you can set up recurring transfer rules with your bank so that the same day your paycheck is being deposited, money is automatically transferred to the right savings plan.

80%: Expenses

Expenses can be broken down into needs and wants.  

The needs are your fixed expenses you know you will have to pay each month. These are the things you would not be able to go without and are necessary to live your life:

  • mortgage or rent
  • utilities: gas, electric, water, sewer
  • health care
  • basic groceries
  • transportation
  • childcare

The wants category contains all the things you want, but don't need to survive. This category includes things like:

  • cable/internet/phone
  • restaurants and dining out
  • entertainment
  • personal care
  • shopping
  • travel

As you evaluate your wants, you may find that you have competing priorities and limited resources. This is when it can be valuable to use the money dials exercise by personal finance writer Ramit Sethi. In his book, I Will Teach You to Be Rich, Ramit takes readers through a thought experiment.

He says to imagine your spending categories like dials on a stereo. To successfully align your spending and your life, identify which categories are most important to you, and which are least important to you. Then, imagine what it would be like to turn the important dials up to a 10/10, and the less important dials to a 1 or 2 out of 10. In other words, maximize your spending in the areas that bring you joy, and cut back mercilessly on things that don't.

For example, if you love to travel, consider allocating additional resources within your wants category to take some extra vacations this year. And knowing that the money has to come from somewhere, imagine that clothes or dining out are not as important to you. Don't hesitate to turn down your clothes and dining out dials, while ramping up your travel budget.

The key to a budget that works is aligning your spending and your interests. That's how you can maximize the enjoyment you get from your money and stick to a plan because you want to.

In the end, the best budget is the one you will stick to. Remember that a budget is simply telling your money where to go rather than wondering where it went. You know best what's important to you, so structure your finances to maximize the things you love, and don't be afraid to cut back mercilessly on the things you don't.

Range is here to help.

With Range, you can connect all your finances into a single dashboard and collaborate with a financial planner to track, monitor and plan the best version of your life. Say goodbye to spreadsheets and hello to the new financial you.

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