February 26, 2021
3 min read
Nicholas Flaherty - Investment Strategist - FWU Invest S.A.
For those of you that have started to think of the future and retirement, you have likely asked yourself how much money you should be setting aside every month or every year. No doubt, it’s a very personal and potentially daunting question, but luckily there are some good rules of thumb that will allow you to find the answer.
One great rule of thumb when it comes to budgeting personal finances is the so-called 50/30/20 rule. It states that after paying taxes, you should budget in a way that 50% of your income is spent on the ‘necessities’ of life, so that means paying for rent, all the monthly bills or on basic groceries. Then, 30% can be budgeted on the ‘fun stuff’, so this is money that goes towards for example the Spotify or Netflix subscription, also going to restaurants, the movies or shopping. We then come to the last 20%, which is so often neglected, usually in favour of the fun stuff! This is understandable, but dangerous nonetheless because this 20% is being dedicated to your future self, who in the end will be extremely grateful. In other words, 20% should be allocated towards savings. This 20% shouldn’t be a maximum, but rather a minimum, i.e. one should budget in a way that at least 20% of after-tax income can be placed into savings.
Let’s go through a brief example.
Let’s say your after-tax income is 2000 EUR a month – nice round number. Using the rule, this means you should be spending up to a maximum of 1000 EUR a month on the ‘necessities. So, it’s unlikely that you can afford an apartment for 800 EUR a month unless you are lucky enough to get all your utilities and groceries for free!
If you are in a situation where you are spending say 1000 EUR a month on rent, plus utilities etc. adding up to 1300 a month, then it would make sense to scale down and bring the rental cost down to a more manageable 700 a month. But say we’ve budgeted well and come in on exactly 50%, so we are spending 1000 EUR on basics, then we have 600 EUR to spend on fun things – the ‘wants’! This means numerous trips to the cinema or even the odd shopping spree. Finally, once our ‘desires’ are taken care of, we have another 400 EUR left over, which we should dedicate towards saving. Part of this should be set aside for ‘emergencies’, so in a situation where you really might need cash on hand, but the large part of these savings should be invested, allowing you to grow your money!
To, then, come back to the original question – how much can I afford to set aside? A really good rule of thumb is 20% of your income, but it is dependent on sticking to the plan strictly and not neglecting the necessities or, in order to enjoy life, the desires.