For almost all of us, there is always something new we could spend our money on. Do you need a Peloton? Probably not. Do you want one? Most certainly. Unfortunately, very few of us get to a point in which our spending habits do not have a material impact on our financial future.
With the understanding that there are unlimited purchases we could make, it is critical that we formulate a savings plan that we can consistently implement over a long period of time.
This is where the 30% rule comes into play.
Lifestyle Inflation
Before we dig into the 30% rule, we need to understand the root of the problem as it relates to our saving and spending habits.
Lifestyle Inflation: Lifestyle inflation refers to the concept that as income rises, spending tends to rise with it.
An Example: After graduating from college, you move in with two friends in a three bedroom apartment paying $1,000 per month in rent with a salary of $60,000. Two years later, you get a promotion and now make $100,000. With your new salary, you move into a one bedroom apartment paying $1,800/month in rent. While it may seem like you are better off, you are now spending roughly 22% of your gross income on rent per year (an increase from 20% before the raise).
As you can see, lifestyle inflation can sneak up on you rather easily. Our previous example used an increase in rent to illustrate the point. Think about all of the other things that could cause your expenses to rise over time:
- Higher income taxes
- Starting a family
- Medical expenses
- Gym memberships
- Social memberships (i.e. a country club)
- Eating out more that cooking at home
- Buying your first home
The list of things that can cause your expenses to rise is truly endless. So what should you do about it?
The 30% Rule
The 30% rule is not a new concept. There are a few variations, but the objective is the same:
Have a plan for how much you are going to spend as a percentage of your income.
A general rule of thumb is to dedicate 30% of your gross income to variable/discretionary spending (i.e. eating out, social memberships, gifts, vacations, etc.). Truth be told, 30% is a bit high (but it is a start nonetheless).
Here is a breakdown of a sample spending/saving template:
Benefits of the 30% Rule
Now that you understand how this all works, why do it in the first place?
- Stays with you as income increases: Using percentages to formulate a strategy allows you to grow your savings over time. For example, if you are saving 20% of your gross income while making $100,000 per year, you will save $20,000. If you get a raise and now make $140,000, you increase your savings to $28,000.
- Allows you to spend freely: As you have probably noticed, your spending will increase over time with this system. This allows you to spend freely while keeping it all under control. You are increasing your spending AND your savings. You will be able to sleep well at night knowing you are enjoying your money now while saving for your future.
- Takes the thinking out of it: This is such an easy plan to implement and will keep you out of your own head. All you have to do is continue to grow your career/income (which you were probably doing anyway) and implement the system as time goes on.
Tips For Long-Term Success
- Automate: You are going to want to set your finances on autopilot. Relying on yourself to manually manage your money is a recipe for disaster. Here are a few tips:
- Use auto pay for as many bills as possible.
- Set up automatic transfers to savings accounts from checking accounts.
- Automatically contribute to retirement and investment accounts.
- Automatically rebalance your investment portfolio at regular intervals (i.e. annually).
- Increase saving %: Savings 20% of your gross income is a nice start, but you can do better. Do you best to slowly increase that number over time.
- Don’t overthink it: For those of you with analytical brains, try not to overthink it. There is no need to be perfect. The framework itself will likely lead to a great deal of success over time.
- Get help: At times, your financial situation may get a little complicated. Even more likely, you just might not have the time to deal with it all. Have someone help you implement your personalized strategy and hold you accountable.
- Resources:
- High Income Young Professionals: If you are a six figure earner in your 20s or 30s, Activate Wealth (a Philadelphia based financial planning firm) specializes in working with clients just like you. Take a deeper dive into the 30% rule within their blog “Saving Strategies for Six Figure Earners”.
- General Planning Resources: You can also browse NAPFA, Fee Only Network, and XY Planning Network to search for a fiduciary financial advisor that can help you achieve your financial goals.
Taylor Venanzi, CFP provides advisory services through Activate Wealth, LLC, a registered investment adviser providing advisory services in Pennsylvania and in other jurisdictions where exempted. All written content by Taylor Venanzi, CFP on this site is for information purposes only and shall not be directly or indirectly interpreted as a solicitation of investment advisory services.