It might seem simple but sometimes budgeting can be an overwhelming experience. What do you prioritize? What comes first in your budget list? How much time should you spend planning out your budget?
The fact that you have to track every expense in your life to come up with an accurate budget can be a daunting task, to begin with. The 80/20 budgeting offers a better solution to this issue. It makes tracking your day-to-day spending easier and makes coming up with a budget a far much better experience.
Most Kenyans live paycheck to paycheck without any form of planning concerning their income and expenses. This is a dangerous way to approach your personal finance. The 80/20 rule will help you get your finances back on track and gain control of your spending.
What is the 80/20 rule?
The 80/20 rule is known as the Pareto principle and it is used in the Pareto analysis of businesses. Pareto was an economist who use an illustration to show how the principle works. He noticed that when harvesting his peas, 20% of the pea pods were responsible for 80% of the harvest.
He further proved his observations in Italian macroeconomics. In 1906 he observed that 80% of the Italian wealth was owned by 20% of the population.
How 80/20 rule work in personal finance
The basis of the principle is simply that 80% of results come from 20% of input. This assumption has two meanings pertaining to budgeting and savings in one’s life. In your budget, the 20% is what you pay yourself as savings and the 80% will go to making your living comfortable.
Let’s look at an example. Let’s imagine I am an entity like a limited company. As an entity, I have Expenses and Revenue. If my expenses are more than my revenue then I am not a profitable entity and I might be looking at bankruptcy soon.
This applies to personal finance too. If your personal expenses are higher than your income, it means you are broke, regardless of how many assets you have.
Back at the company, if we want to bring it back to profitability we have two options, increase our revenue or cut back on our expenses. Further profitability will be achieved if we can increase our revenue and cut back on expenses.
Ironically, the 80/20 rule will be applied to identify the most crucial parts of the business that should be accelerated and the least useful expenses that should be cut.
In your personal budget, 20% will be your personal profit from your earnings. The 80% will be used to take care of your expenses. Like a good business, you must be vigilant to ensure you are increasing your profits, either through increased earnings or ruthlessly cutting down on unnecessary expenses.
The Pareto principle can be observed in savings too. The 20% saved will be more crucial to your life goals than the 80% you will spend on the day-to-day running of your life.
Note that, this does not make the 80% less important. This is a fallacy. What it means is simply that you chose to prioritize the 20%.
80/20 Rule Budget
The 80/20 budget is a percentage breakdown budget method where we break our budget down into percentages. It dictates that you first save 20% and spend 80% on your expenses.
The 80/20 rule emanates from the 50/30/20 rule which is used to cut the expenses into 50% needs and 30% wants. The 80/20 rule combines wants and needs into one category, expenses.
The budget percentile for the 80/20 rule should look like this:
- 80%-personal expenses
- 20%-savings.
Advantages of using the 80/20 rule
The 80/20 is an easy budgeting tool and can help you get your budget in order quickly. It has several advantages which make it a suitable tool for those on the go.
- It is very simple. The 80/20 rule is very simple to follow. It gives you a fixed number to work with regardless of your income. It does not stipulate fixed spending which many might not be good at following.
- Easy to turn into a habit. It is very easy to internalize the 80/20 rule into the day-to-day running of your finances. You can make a budgeting habit without any need for apps or special tools. It requires the discipline of sticking to the stipulated rule.
- Automate your savings. You already know how much to expect each month, it’s a matter of arranging with your bank for 20 percent of it to go to your saving account. This will save you the temptation of spending the money while it is still accessible.
- Time efficient. In the modern world, things move fast and so should your budgeting needs. You can set your 80/20 budget in a matter of minutes since it has just two inputs to take care of.
- Excellent reliability. By giving you the 80%, you get to decide how to spend most of it but always ensure that you have saved first. This leeway gives you maneuvering when it comes to your expenses. You don’t need fixed spending as long as it is below the stipulated 80% each month.
- It can be nested. In computer programing, the ability to nest a function inside another one makes programs much more efficient. The 80/20 rule can also be nested. You can move from just saving to also applying it to the expense itself to identify the 20% of expenses that take up 80% of your budgeted spending.
Conclusion
The 80/20 rule started in macroeconomics in the 20th century. Over time it has proven itself and filtered into every industry and finally personal finance.
The 80/20 rule can be applied in budgeting to encourage more savings. It saves time by having a few variables that need to be addressed each month. It can be automated for those with fixed monthly salaries.
Finally, can you tell us what kind of budgeting rule you use? How is it working for you? Do you think the 80/20 rule can improve your budgeting and saving needs?