According to a recent survey by Bankrate, 52% of Americans say that their retirement savings are not enough to see them through their golden years. Maybe they started late, took an early withdrawal, or were not consistent with their savings.
While there is no hard and fast rule to saving and budgeting, the 80/20 rule of thumb for retirement can be a useful tool regardless of when you're beginning to build your nest egg.
Read on to learn more about this rule and how it can help you to achieve your financial goals.
What is the Pareto Principle?
The Pareto Principle, also known as the 80/20 rule, is named after Italian economist Vilfredo Pareto and states that 80% of the effects come from 20% of the causes. In other words, a small number of factors are responsible for the majority of the results or a small amount of effort can lead to a large number of results.
The Pareto Principle can be applied to business, economics, psychology, productivity, and even personal finance. It's important to remember, though, that while not an exact science, it can still be useful, especially in money management.
How the 80/20 Rule Works
As already established, the Pareto Principle can be applied to many different situations. Here are some examples of how it works:
- Sales: Most businesses get 80% of their sales from 20% of their customers. This means that those businesses can boost sales significantly by focusing on the top 20% of customers.
- Productivity: 80% of a company's productivity can come from 20% of its employees. By motivating the 20% of employees that generate the most results, you can get the most out of your business.
Here's how it works when used as the rule of saving money.
- Retirement savings: Out of your entire paycheck, 80% goes towards personal expenses, including housing, food, entertainment, healthcare, and transportation.
The remaining 20% of your income goes to debt repayment, investment, or savings. This helps you put aside money for your long-term financial goals and create a wealthy retirement income.
While it may seem straightforward enough, when applying to personal finance, you may need the services of a registered retirement consultant to ensure that you are doing the right thing.
Benefits of the 80/20 Money Rule for Retirement Savings and Investment
Whether you’re just starting out saving for retirement, or already have a bit of a nest egg, the 80/20 rules to save money can help you make the most of your retirement savings so that you can retire wealthy.
- Increased savings rate: One of the biggest benefits of using the Pareto Principle for retirement savings is that it can help you increase your savings rate. If you save 20% of your income, you will likely have a much higher savings rate than if you only save 10 or 5 percent.
- Reducing expenses: The 80/20 rule for investing can also help you identify the 20% of expenses that are responsible for 80% of your income - money that can be channeled into your retirement savings. By focusing on reducing these expenses, you can free up more money to save.
- More money for retirement: Using the 80/20 percent financial rule can also help you have more money in retirement. This is because the 20% you save can compound over the long term and provide you with a bigger nest egg.
- Better investment choices: According to the Pareto Investment Principle, 80% of investment returns can be expected from 20% of investments. Concentrating your investment decisions on the 20% of investments that are likely to generate the biggest returns may help you grow your savings faster.
- Guard against risk: People can use the 80/20 investing rule to mitigate risk. Putting 80% of their savings into safe investments and the remaining 20% into riskier growth stocks can serve as cushioning against market uncertainties.
What is an 80/20 Retirement Plan?
An 80/20 retirement plan is a type of retirement plan where you split your retirement savings/ investment in a ratio of 80 to 20 percent, with 80% accounting for low-risk investments and 20% accounting for high-growth stocks.
Typical examples of this plan are:
- Put 80% of your money into retirement accounts like 401ks or IRAs, and 20% in high-yield investments.
- Invest 80% of your money in passive index funds or ETFs and the remaining 20% in real estate.
- Put 80% of your money into blue-chip stocks and 20% in bonds or small and midsized companies.
- Invest 80% of your savings in real estate and 20% in bonds.
The idea is that 80% will provide a steady, reliable income in retirement, while 20% can provide a potential boost if it performs well.
There are a few things to consider before looking at the 80/20 retirement rule. First, you need to make sure that you're comfortable with the level of risk involved in the higher-risk investment. You also need to make sure that you're investing the 20% in a way that makes sense for your overall. This is where holistic financial planning advice can help.
Retiring Wealthy with the 80/20 Principle: 7 Tips & Best Practices
Retiring wealthy is possible thanks to the Pareto rule of 80/20. But how do you get started? Here are some money-saving and budgeting tips to help you improve your investment strategy:
- Pay yourself first
Thinking of how to retire wealthy? One of the most important things you can do for your retirement is to pay yourself first. This means setting aside a fixed percentage of your income each month to go toward your retirement savings. According to the Pareto Principle, this should be at least 20% of your income.
- Control your expenses
80% of your biggest expenditures typically come from 20% of your lifestyle choices. This can affect your savings potential. Take a close look at your spending habits and see where you can cut back. Remember the 80/20 budget rule, the less you spend, the more you can save.
- Minimize your debt
Debt can be a major drain on your savings, so it's important to try to pay it off as soon as possible. If you're carrying a lot of debt, make a plan to pay it off over the next few years. Then learn how to save and budget money so that you don't go back into debt.
- Invest at least 20% of your income
Investing a percentage of your earnings is essential for increasing your savings. You may grow your wealth over time and benefit from compounding interest by dedicating at least 20% of your income to investments.
- Diversify your portfolio
Invest in a mix of traditional (401k, IRA, such as stocks, bonds, and mutual funds) and high-growth securities (venture capital, private equity, or real estate) in a ratio of 80:20. A diversified portfolio will help you weather the market ups and downs.
- Focus on investments that generate the most returns
Not all investments are equal, and some produce better returns than others. Identifying and concentrating on your portfolio's top-performing investments will help you optimize your profits while limiting your risk.
- Work with a financial advisor
Finally, to make the most of your investment when saving for retirement, you must work with a financial advisor. This individual can help you develop a strategy that is tailored to your specific goals and circumstances, then track and make adjustments as needed.
Need Help with Retirement Planning?
Federal Reserve statistics show that 25% of Americans do not have any retirement savings. But it's never too late to start, and Interactive Wealth Advisors can help.
Our investment management Oregon professional service is designed to help you create a retirement plan that fits your unique needs and goals.
At IWA, we take a comprehensive approach to financial planning, taking into account your financial situation, your goals, and your timeline. We then create a personalized plan that includes budgeting to save money, investing, and tax planning services to help you make the most of your retirement years.
We also offer expert asset protection to help protect your personal and business wealth.
If you're ready to start planning for your retirement, we're here to help. Get in touch today.