Budget. Does anyone like that word? How about this instead—the 50/15/5 rule? It's our simple rule of thumb for saving and spending: allocating no more than 50% of take-home pay to essential expenses, 15% of pre-tax income to retirement savings, and 5% of take-home pay to short-term savings. (Your situation may be different, but you can use our rule of thumb as a starting point.)
Why 50/15/5? We analysed hundreds of scenarios in order to create a saving and spending guideline that can help people save enough to retire. Our research found that by sticking to this guideline, there is a good chance of maintaining financial stability now and keeping your current lifestyle in retirement.
Step 1. Essential expenses: 50%
Some expenses simply aren't optional—you need to eat, and you need a place to live. Consider allocating no more than 50% of take-home pay to "must-have" expenses, such as:
- Housing: Mortgage or rent, council tax, utilities (like electricity and gas), and home insurance.
- Food: Groceries only; do not include takeaways or restaurant meals, unless you really consider them essential, i.e. you never cook and always eat out
- Transport: Loan/hire purchase agreement, fuel costs, car insurance, road tax, parking, tolls, servicing and MOT costs, and bus and rail fares
- Child care: Day care, tuition and fees
- Debt payments and other obligations: Credit card payments, student loan payments, child support, and life/critical illness insurance
Keeping it below 50%. Just because some expenses are essential doesn't mean they're not flexible. Small changes can add up. Try turning down the thermostat a few degrees in winter, buying groceries when they are on sale, and taking your lunch to work.. If you need to significantly reduce your living expenses, consider a less expensive home or apartment.
There are many other ways you can save. Take a look at which essential expenses are most important, and which ones you may be able to cut back on.
Step 2. Retirement savings: 15%
It's important to save for your future—no matter how young or old you are. Why? The state pension isn’t going to provide all the money you need to live the life you want in retirement. In fact, we estimate that about 45% of retirement income will need to come from savings.
That's why we suggest people consider saving 15% of pre-tax household income for retirement. That includes your contributions and any matched contributions from your employer. Starting early, saving consistently, and investing wisely is important, as is saving in tax-advantaged pension schemes and savings accounts.
How to get to 15%. If contributing that amount right now is not possible, an employer may have a program that automatically increases contributions annually until a goal is met. Another strategy is to contribute at least enough to meet your employer’s pension contribution match, and then allocate all or part of a pay raise or bonus to savings.
Step 3. Short-term savings: 5%
Everyone needs an emergency fund. An emergency, like an illness or job loss, is bad enough, but not being prepared financially can only make things worse. A good rule of thumb is to have six months of essential expenses readily available. Think of your emergency fund contributions as a regular bill every month, until you have built up enough.
Once a sufficient emergency fund is in place, it’s a good idea to turn to saving for short-term expenses that pop up unexpectedly. Who hasn't been invited to a wedding—or several? Cracked the screen on a smartphone? Punctured a tyre? Setting aside 5% of monthly pay can also help with these "one-off" expenses.
Don't be tempted to pay for one by adding to an existing credit card balance. Over time, these balances can be hard to pay off. However, if you pay the entire credit card balance every month, and get points or cash back for purchases, using a credit card for one-off expenses may make sense.
How to get to 5%. Having this money automatically taken out of your current account on, or soon after, pay day and put into a separate account just for short-term savings can help you reach this goal.
Our guidelines are intended to serve as a starting point. It is important to evaluate your situation and adjust these guidelines as necessary. If you're close to the 50/15/5 target spending and saving amounts, good job. And for those staying within the guidelines, any remaining income is yours to save or spend as you like.
First, pay off high-interest debt. For other goals, like paying for a child's education or wedding, you could use the remaining income to save for them. And, finally, if you want to retire early, or haven't been saving diligently, putting it toward retirement savings may make sense.
The good news is that it isn't about micromanaging every penny. Analysing current spending and saving based on our three categories can give you control—and confidence. Undoubtedly, a financial situation will change over time. A new job, marriage, children, and other life events may change cash flow. It's a good idea to revisit spending and saving regularly.
The value of investments can go down as well as up, so you may not get back the amount you originally invest. Withdrawals from a pension product will not normally be possible until you reach age 55. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.