A simple three-step approach to saving and spending

To manage your saving and spending, you should think about creating a budget. This can be simplified into three easy steps. Our simple approach for saving and spending is firstly, to allocate no more than 50% of net income to essential expenses, secondly, make sure you are saving enough for retirement, and lastly keep 5% of take-home pay for short-term savings.

Why these three steps? The 50%, 10%+, and 5% are guidelines only, not formal advice – they will vary according to your individual circumstances. These general practices can help provide perspective on what you need to consider to maintain your financial stability now and keeping your current lifestyle in retirement.

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 half of your net income to “must-have” expenses, such as:

• Housing—mortgage, rent, property tax, utilities (electricity, internet, etc.), and homeowner’s/renter's insurance.
• Food—groceries only; do not include takeout or restaurant meals, unless you really consider them essential, i.e., you never cook and always eat out, or you eat out daily when at work.
• Health care—whether you pay for supplemental health insurance premiums and any part of your medical expenses (e.g. a portion of the cost); or whether you pay for healthcare expenses not covered under your government or employer program such as private providers, elective surgeries, dental care, vision, prescription drugs, etc.
• Transportation—commuter fares, taxis/ridesharing, or costs of your own car/bike (loan, petrol, insurance, parking, tolls, and maintenance).
• Childcare—day care, nursery school or pre-school, kindergarten, school-age childcare, tuition and fees.
• Debt payments and other obligations—credit cards (including online/mobile loans), loan payments, child support, alimony, and life/disability insurance.

Try to keep the total below 50%: just because some expenses are essential doesn’t mean they’re not flexible. Small changes can add up, such as using energy-efficient lights and appliances, buying—and stocking up on—groceries when they are on sale, and bringing lunch to work. Also consider driving a more affordable car / bike, sharing rides (carpooling or car sharing), or taking public transportation.

There are many other ways you can save. Consider which essential expenses are most important, and which ones you may be able to cut back on, especially if you tend to have to borrow to meet your expenses.

2. Retirement savings: 10%+

It’s important to save for your future—no matter how young or old you are. Why? More countries - and employers - are looking into moving away from pension plans that guarantee a benefit amount upon retirement. Social Security programs and other statutory retirement plans are increasingly struggling to guarantee the future solvency of their programs and meet the needs of aging populations. In many cases, these retirement programs that people have relied upon in the past probably won’t provide all the money a person needs to live the life they want in retirement.

In fact, we’ve estimated that individuals in some countries may need to target between a third to half of their pre-retirement income to come from savings to supplement their social security benefits. Based on these savings goals, most individuals will need to save additional amounts through a combination of employer-sponsored and private pension arrangements.

How do I know my retirement savings goal? Do some research with your current pension plan administrator or your country’s retirement program authorities. Some general estimates may be publicly available, or your pension plan administrator may be able to provide some guidelines. The goal would be to estimate what portion of your pre-retirement income will be replaced by your existing legally required plans and what is your recommended annual savings rate to supplement that benefit. We’ve seen this recommended annual savings rate vary significantly but it’s generally over 10% of your gross salary.

How to get to your retirement savings goal? Take advantage of any existing tax-efficient savings programs such as company-sponsored plans, where your employer may also be contributing. Starting early, saving consistently, and investing wisely is important. If the total contribution of more than 10% (for both your employer and you) is not possible, try starting with a lower contribution and increase it gradually over time (eg. 1% annually) until your goal is met. If you have not already done so, ensure that you benefit from the maximum additional employer contributions that may be available through a company-sponsored plan (typically done in a matching manner, so you have to invest more to benefit). In some countries, you may also be able to allocate a portion of your annual raise or incentive pay (bonus, commissions, etc.) in a tax-effective way into an individual retirement account up to a pre-defined threshold.

3. Short-term savings: 5%

Everyone can benefit from having an emergency fund. It is intended to cover unexpected expenses which may result from a prolonged illness, household repairs or medical expenses. A good general rule is to have enough put aside in savings to cover 3 to 6 months of essential expenses. Think of emergency fund contributions as a regular bill every month, until there is enough built up.

While emergency funds can be for more significant events, like job loss, we also suggest saving a percentage of your pay to cover smaller unplanned expenses. Who hasn’t cracked the screen on a smartphone? Had transportation problems? In addition to those, there are certain category of expenses which are often overlooked, for example; maintenance and repairs of cars/bikes, special celebrations, extra healthcare expenses, holiday events, to name a few. Setting aside 5% of monthly net income can help with these "one-off" expenses.

It is good practice to have some money set aside for the random expenses - this way you won't be tempted to tap into your emergency fund or tempted to pay for one of these things by adding to an existing credit account or by getting a loan - over time, these balances can be hard to pay off. Paying the entire credit card or credit account balance every month will help you avoid paying high interest amounts and other charges.

How to get to 5%: You may be able to get this money automatically taken out of your regular pay and deposited in a separate account just for short-term savings. You could also set up a monthly deposit through your bank or other financial institution once you receive your pay. Saving this amount in an account that pays interest rates would help you reach this goal a little sooner. The key is automation – doing it upfront when the money comes in is easier than trying to allocate it at the end of the pay period when finances may seem tight.

What next?

Our guidelines are intended to serve as a starting point. It is important to evaluate your situation and the options available locally or through your employer to adjust these guidelines as necessary. If you’re already following these steps or have reached these spending and saving amounts, good job! And for those staying within the guidelines, any remaining income is theirs to save or spend as they would like.

Consider the following ideas:

• First, pay down high-interest debt.
• Establish other goals, like paying for a house improvement or a wedding; you could use the remaining income to save for them.
• Finally, for those who want to retire early, or haven’t been saving consistently, putting extra money toward retirement savings may make sense.

The good news is that it isn’t about micromanaging all your money. Analysing current spending and saving based on our three categories can help give you control—and confidence. Almost everyone's 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, particularly after any major life events (such as getting married, having a child, buying a house, etc.).