The first thing you will want to do is allocate your after-tax income into the following “buckets”. You can do this using the envelope or jar system, where you remove cash from the bank, or using separate bank accounts, whether by automatically or manually transferring the funds to each account. Regardless of how you do it, it is highly recommended you physically separate the funds and have the name of the funds on each account/envelope/jar. Do not just track it on paper or an Excel spreadsheet as it will not work as well for you. There is a psychological benefit to having a visual so you can see how much you have accomplished and what you have available.
These are the allocations recommended by millionaires and billionaires:
Invest in Your Long-Term Future (future you) 10%
This is the amount you are going to use in the future to obtain financial freedom. You want to invest these funds as follows: 10-20% high risk, 50-60% medium risk, 20-30% low risk. We will discuss risk levels in a future blog. Invest based on your personal risk level. If you are a risk-taker, invest a little more in high risk investments. If you are risk-adverse, invest a little more in low risk investments. Risk tends to correlate with reward. The higher the risk, the higher the potential reward. But, there is also a chance you could lose everything. This is why diversification is to important. You do not want to build up a fortune in high risk investments and then lose it all. By keeping a diversified portfolio you will protect your future while potentially benefiting from the potential rewards of high risk investments. Do not get greedy or swept up in the euphoria of a winning streak.
Play 10%
These funds are for you to have fun. Use it to pamper yourself. Go on a trip. Buy an ice cream. Go out for dinner. Whatever you find fun.
Invest in Yourself (education) 10%
These funds are to use to learn something new. This includes your membership fees for this club and to pay educational loans. Attend conferences. Buy a book. Take lessons. Learn a new skill. If you are not growing you are dying, so make sure you continue to learn and grow.
Invest in Your Short-Term Future (savings) 10% or up to 12 months living expenses
These are the “rainy day” funds you are going to need to turn to when the unexpected happens. If you lose your job, have a major repair or breakdown, or want to buy a house, you will be glad you have your savings.
Ideally, you will have a separate savings account for planned major life events like a wedding, baby, dream trip, etc.
Invest in Others (give) 5%
This is the money you give away, whether you call it tithing, donating, or any other term. The idea is that you are so grateful for the abundance in your life that you want to share the wealth with others. You will find in the future this percentage will increase as you find yourself becoming more financially free.
Living Expenses 55%
These are your basic expenses- shelter, food, utlities, car, cell phone, insurances, etc. If your current basic living expenses exceed 55%, find ways to reduce them. Move to a smaller house, cut the cable, negotiate a lower internet bill, find a different cell phone plan, buy a refurbished phone instead of financing a new one through your cell phone provider…the list goes on and on. I am not saying to give up things that bring you great pleasure- those things you can purchase with your “play” money- just be mindful of things you are paying for that you may not really need or are paying more than you really have to.
We will go further in depth into these “buckets” in future blogs. Please feel free to comment with any questions, concerns, or your own experiences.