The Money Professors

The 3 Steps to Eliminate Budgeting for Good

Step 2 - The 20% Solution

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In the previous post, we talked about setting up your bank accounts with automatic transfers so your money was already divided into broad categories of must-pay or likely-pay items. This time we will take a look at how we build our emergency, maintenance, repair, and replacement funds.

So what is the 20% solution and how does it end the need for budgeting? It is simple really. Anytime you make a purchase on anything other than consumable items (food, household goods, etc.) - you set aside 20% of the price in your savings account. See how easy personal finance really is?

All you have to do is set aside an extra 20% each time you make a purchase. Now, you may not be able to go back now and add that in to your current expenses, but you can still do so going forward.​

I can already hear the objections:

  • What about an emergency fund? Solved. You are creating the emergency fund by setting aside 20% of your spending on big ticket items, etc.
  • What about a car purchase? I can't set aside $4,000 if I buy a $20,000 car. Solved. If you are making monthly payments, you should be setting aside 20% of the monthly payments. A $400 per month car payment = $80 in your savings account each month.
  • What about my mortgage? It's $1,500 per month. Solved. Set aside $300 per month.
  • How does this help make sure my other fixed expenses are being paid? Solved. Use common sense. Of course you have to first figure out what your fixed expenses are and set that money aside. It will likely come out as an automatic EFT directly to the companies anyway.
  • What about paying off debt? Shouldn't that be a higher priority than saving the 20%? Solved. Your goal should be to establish about $1,000 or one month's rent or mortgage (whatever is larger) in an emergency fund. Once that is funded, you can use the money from the 20% rule to actually pay down your debt.

Getting out of debt is another discussion, but here is the concept of the 20% solution: For all new purchases going forward, if you cannot afford an extra 20% to put away in savings, then you cannot afford the purchase. And yes, that goes for homes and cars as well. If you can't set aside an additional 20% of the the mortgage or car payment, then you cannot really afford that purchase.

That doesn't mean you have to actually set the money aside. You have to be able to afford to set the money aside. Now you do have to do something with that money and you cannot keep counting the same extra dollars for every purchase. So you might just put it in your emergency fund. or you may use it to pay down debt. Or you may use it to increase your investments. Whichever you do is up to you. But regardless, this is money that improves your situation, not some banker's, lender's, or retailer's situation.

So the next time you need a new refrigerator, iPhone, or television, make sure you set aside 20% extra. Now you can stop worrying about your budget and start enjoying your growing savings account or your shrinking debt.

Next time we will look at Step 3 - The Goal Prioritization Solution

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Bill Pratt

Bill is an Assistant Professor of Business at Piedmont Virginia Community College. He speaks on topics related to personal finance on college campuses across the country and is the author of multiple books on personal finance. He left the financial industry to focus on helping people become personally and financially successful. He lives in Charlottesville, VA with his wife and their three pets.

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