What is the 70:20:10 rule?

The 70:20:10 rule is one of the most common saving mantras of all. It’s a formula for money management that anyone can follow, whether you are earning minimum wage or sitting on a small fortune.

In short, the 70:20:10 rule dictates that 70 per cent of your paycheck should be used to cover your living expenses; 20% should be saved or invested; and 10% should be used to pay off debt.

This formula applies to your take home pay only, or the money that is left over after you have paid off your taxes. This is an important point to remember, especially if you are self-employed and don’t have your taxes automatically deducted by your employer.

Let’s say your take home pay is £2,000 per month after tax. The 70:20:10 rule dictates that you will have £1,400 to spend on living expenses, £400 to invest or save, and £200 set aside to pay down your debts.

What does this mean in practice?

The 70

We all have bills to pay and groceries to buy. The first 70% of your paycheck should be able to cover all of your living expenses, whatever they may be.

For most of us, the biggest chunk of this will go towards rent or a mortgage. Then there are your bills (electricity, gas, broadband, water), and day-to-day essentials such as gas, groceries, and clothing.

Don’t forget the one-off expenses which can creep up on us – birthday gifts, vet bills and household repairs, to name just a few. And then there your other financial obligations, such as insurance payments, professional fees and membership fees.

This 70% portion should also bring you a little bit of joy. Holidays, date nights and socialising should fall under this category so that you can actually enjoy your earnings!

However you spend the first 70% of your paycheck, just make sure that you don’t exceed that 70% marker. If you can’t afford to meet all your living expenses with this money, you may need to revisit your household budget to make it work. The 70:20:10 rule only works if you can stay within the boundaries.

The 20

This is probably the most valuable money you earn. The 20% that you save or invest will allow you to build up a solid nest egg which will (hopefully) earn even more money through interest and dividends over time. This money can be saved, invested or both.

Savings are generally kept in a bank account where they will steadily accrue interest with minimal risk. However, the interest rate will be as low as it gets. If you choose an easy access savings account, you are likely to earn less interest. Notice accounts (where you must give several months' notice before making a withdrawal) may slightly higher interest rates.

Investing comes with a lot more risk than saving, but the returns can be amazing. If you invest in a company that performs badly or goes under, you could lose your entire investment. However, this risk can be managed by spreading your money across a range of stocks and shares. In theory, the more investments you have, the lower the risk that you will lose your money. There are many tools available to help you create and maintain a diversified investment portfolio. Ideally, your portfolio will contain a mix of high-risk, high-return and low-risk, low-return options, so that they even out to give you annual returns of four per cent or higher.

Most experts recommend holding a combination of both savings and investments in your portfolio. It can be invaluable to keep a certain amount of ‘rainy day’ money in an easy access savings account, just in case you need it in a pinch. However, by taking a little time and creating an investment portfolio alongside your cash savings plan, you can really maximise your money.

It’s vital that you do not dip into your savings or skip a couple of months, unless it’s absolutely unavoidable. Part of the magic of saving money is that once you reach a certain threshold, the interest that you earn can far exceed the amount that you are saving every month.

For instance, if you have been putting aside £400 per month for two years without making any withdrawals, you will build up a total savings pot of £9,600. If you can earn four per cent interest on that £9,600, that’s another £384 that you will earn without doing anything at all. The longer you save, the more quickly your money will grow thanks to these annual interest payments.

The 10

Finally, 10% of your earnings should be earmarked for debts or donations. That 10% should be able to pay off your credit card bills, personal loan repayments, car payments, and student loans. If you are struggling to meet your debt obligations, you may qualify for financial help, or you may be able to consolidate your debt into more manageable monthly payments.

If you are lucky enough to have no debt to speak of, this 10% can be diverted into your savings and investments portfolio or donated to the charity of your choice.