At the heart of the 2% rule is gradual change, something that can be achieved and maintained
I read an interesting book about getting out of debt last week, written by Alex and Cassie Michael. I liked their approach, and given how successful they were at using it, I feel it is worth considering and applying their strategy.
As the saying goes, success leaves clues, so we should take notice of people who succeed at something and find out what they did.
And the Michaels produced outstanding results because over a relatively short period of time (three years), they paid off the $108,000 they had accumulated in consumer debt.
They achieved this by applying the 2% rule to their monthly budget. This rule was so called, because they made changes to the amount they spent each month in 2% intervals.
At the heart of the 2% rule is gradual change, something that can be achieved and maintained. The majority of people will tell you that debt can accumulate over time, and the way we live and spend our income each month becomes very similar over time as well.
If you look at the amounts, and what you spend your money on each year, a pattern will develop and it’s hard to change something you have been doing for years in a short period.
It takes time to break financial habits and doing it in a manner that doesn't impact your quality of life either. Some people vow to get out of debt and start off by slashing their outgoings by as much as 20%. What they quickly find out (a month or two later) is that it’s just not sustainable. They feel deflated that it didn’t work, and rather than try something different, they give up and go back to their old ways and as a consequence make no inroads into their debt.
I like the 2% rule, because it’s not very complicated, and it doesn't need to be. That gradual change really has the ability to help you get out of debt or increase the level of your savings.
How the 2% rule works
1. Track your outgoings for one month.
2. Once you know how much you spend and on what, reduce your outgoings by 2% the following month.
3. Apply the 2% saving to your debt or your savings account.
Let’s assume your monthly outgoings are €3,000. The target amount you are going to set yourself to spend next month is €2,940, so you are looking at spending €60 less, 2% of €3,000.
You may not meet your target every month, and that’s okay, but your goal is always to spend 2% less than you did the month before.
At the heart of this plan is to use those 2% monthly savings in an effective way. That could be paying off credit card debt, adding to your savings fund for a holiday, or for whatever reason is most important for you.
If you had a credit card for example and the balance outstanding was €5,000, the interest rate 20%, and your monthly minimum payment €100. It would take you nine years to pay it off in full, paying €5,840 in interest.
By diverting that 2% saving in expenditure each month, and adding it to the minimum repayment, using the same numbers in the example outlined, the debt would be repaid in 3.7 years, and the amount of interest paid €2,121.
That 2% monthly saving in this instance, which is only finding €2 per day, reduces the time you are paying that debt by c. 5.5 years with interest savings of €3,359.
A small gradual change to your spending each month can have a significant impact on your finances. You won’t feel overwhelmed and you won’t feel it’s having too much of an impact on your quality of life when you continue with it each month either. And you are more likely to stick with it; that’s the key to improving your financial situation.
So, you don’t have to adopt a slash and burn approach to your monthly outgoings, just spend 2% less than the previous month.
And to help with this, it’s important to group your monthly outgoings into different, distinct categories because it will make it easier for you to identify areas that you can reduce your spend on for the following month.
It can really help if you take this one step further and divide a category into sub categories.
Subdividing them will help you reduce your outgoings rather than just picking a number. Delving deeper within a category to identify an area to reduce can help you focus.
For example, if you choose food and drinks as the category you are going to target this month, and you typically spend €800 per month, look at what makes up that €800 and rather than focus on spending €60 less in this area, look at specific categories to focus on; like the amount you spend on coffee, cereals, sauces, pizzas and so on.
There is a great method that can help you with this, which gives you ideas for saving money, without you having to give up buying them altogether. Ask yourself the following:
1. Can I buy it cheaper?
2. Can I make it last longer?
3. Can I use it less?
Using all three strategies together can really make it possible to save money, but even implementing just one will help.
This line of questioning can be applied to almost any area of your monthly outgoings, and obviously it might not apply for every item or service you purchase each month. You might not want to downgrade your coffee, but you might save money by using it less, and end up not having to buy it every month.
Give the 2% rule a chance and see how you get on for a couple of months. I think you will be pleasantly surprised.
Liam Croke is MD of Harmonics Financial Ltd,
based in Plassey. He can be contacted at email@example.com or www.harmonics.ie