Use the 70-20-10 rule in budgeting

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Investors are usually in a sticky spot when managing their personal finances, as they have to spend and save at the same time. The way to overcome this problem is to follow financial discipline with a simple budgeting rule of thumb – the 70-20-10 rule. Here’s how it works.

70% – Essential and discretionary expenses

A significant portion of income is spent on essential and discretionary expenses. The unavoidable expenses of your daily life are categorized as essential expenses. These include utility bills, groceries, medical bills, insurance, rent, and more. Discretionary spending is voluntary, like buying clothes, going out to dinner, or planning a vacation. The rule suggests that 70% of your income should be budgeted for these expenses. Always keep track and periodically review all these expenses.

20% – Savings

Save as you earn! It’s the stepping stone to the world of personal finance management. The rule states that at least 20% of your income must be saved and divided between a provident fund and investments.

A provident fund is a reserve fund that must be set aside for unforeseen circumstances such as medical emergencies or job loss. When building this fund, it is crucial to consider the number of dependent family members and their ages. First, create a provident fund and start investing to achieve your financial goals.

Investments have a cumulative effect. The sooner you start investing, the better your assets grow. One of the best ways to develop a saving habit is to invest through Systematic Investment Plans (SIPs). Just as you pay your EMIs every month, you can save by investing through SIPs every month.

10% – Debt

The rule suggests that no more than 10% of your income should ideally be spent paying off loans or credit card bills. Debt repayment should be well planned taking into account your various sources of income. Pay off your loans early rather than waiting for the end of the loan term. This helps you save interest charges which can be used to reinvest.

Pay your EMIs on time to avoid penalties and maintain a good credit rating. Credit score is a vital indicator of your ability to repay your loans. Financial institutions consider your credit score for risk assessment when you apply for a loan. If you have a good credit history, you are more likely to qualify for a loan with lower interest rates.

The budget rule of thumb may not be the same for everyone. You can choose your own rule based on your financial background, such as 70-10-20 or 80-10-10.

Asset allocation, portfolio rebalancing

Asset allocation plays an important role in building your investment portfolio. Having an optimal asset allocation helps balance your risk and returns. You can invest in various asset classes such as equities, debt securities, cash and cash equivalents, commodities, real estate, etc., which help to mitigate market volatility and concentration risks. A well-diversified investment portfolio can be built based on your short and long term financial goals like buying a new car or house, getting married, international vacations, raising kids , retirement, etc. It is important to periodically rebalance your investment portfolio to maintain target asset allocation and achieve short-term financial goals. For example, while rebalancing your stock portfolio, you can take profits in outperforming stocks and invest in underperforming stocks.

Taxation

Taxation is an important aspect that must be taken into account when managing your personal finances. All financial products have different tax implications and benefits. Investing in tax-saving instruments can be a win-win situation because it saves taxes and creates wealth. With thorough research and guidance from your financial advisor, you can navigate the tax planning process seamlessly.

The fear of missing out (FOMO) effect is often seen among investors when making investment decisions. Controlling your emotions and investing wisely is the key to successful investing. Much like online shopping, investments can be made through one-stop fintech platforms. Don’t let every investment opportunity overwhelm you and lead to impulse decisions. An experienced financial advisor can guide you through your entry into the world of personal finance management.

The author is co-founder, Wint Wealth

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