The 60/20/20 Rule For Savings

While you’re building your savings and investments, you will need to decide how to allocate your money. There are several ways to do it, but I’ve found that one of the best methods is to use the 60/20/20 Rule. I first learned of this method from using the Money Mastery® money management program Money Mastery.

Here’s the way it works…

60% of what you save is allocated to long-term investments.

20% is allocated to an emergency fund.

20% is allocated for “emotional spending.”

Long-term investments are critical for reducing your Financial Freedom Number and becoming financially free.

An emergency fund is important for…well…emergencies. Traditional financial planning says that you should have about six months’ living expenses set aside for emergencies — those “unexpected” things that happen like a loss of a job, or unplanned medical expenses, or major repairs.

Emotional spending is defined as spending for things we want, but don’t necessarily need — vacations, a new TV, down payment on a second home, and all the “stuff” we like to accumulate. An emotional spending account is important because that’s what makes saving money fun. And remember, we want to have fun doing this.

So here’s an example of how this could work…

Let’s say that your gross income is $5,000 a month. And, let’s say, at first you can only save 2% of that.

Sidebar: Remember you’re also paying off your debt at the same time. You’re going to eventually be saving 10% of your income. But you have to start somewhere, even if it’s only 1% or 2%.

So you’re saving $100 a month (2% of $5,000).

Here’s how $100 would be allocated according to the 60/20/20 Rule…

$60 into a long-term investment account like a 401(k) account, a Roth IRA, etc.

$20 into emergency savings account like a money market fund.

$20 into an emotional spending account. This could also be put into a liquid account like a money market fund.

However, if it’s for a longer-term goal, you may want to put it into a Certificate of Deposit or a bond mutual fund to get a higher rate of return. If you put it in the same account that you have for emergencies, make sure you know how much of that account is for emergencies and how much is for emotional spending.

As you increase the amount you are saving you will increase the amount going into the three categories. The allocation stays the same until you have about six months of savings in your emergency savings account.

Then you could change the allocation to 80/0/20. In other words, 80% allocated to long-term investments and 20% allocated to emotional spending. You no longer need to save for emergencies because you’ve reached your goal in funding that account.

Simple but powerful.