One of the hardest and most confusing parts about budgeting is really not knowing what your budget SHOULD look like. Truth is that there are no hard and fast rules because, ultimately, your budget is what you want it to be (for better or worse.) That being said, there are some guidelines to help you get started if you are on the path to a balanced budget.
The 50-20-30 Rule
The 50-20-30 rule is a great place to set benchmarks for your budget. The basics are splitting your income to spend 50% on essentials (housing, food, transportation, and clothing), 20% on financial goals like savings and debt repayment, and 30% on wants. Again, this is a great place to start. If you are only spending 30% on needs (go you!) you could choose to put that extra 20% towards rapidly paying off debts or saving for retirement or a 5-star vacation. There is a lot of flexibility in this model, but make sure you follow the order of essentials, savings, wants. If your needs are way over 50% that is when you need to be looking for ways to bring in additional income or lower your needed expenses. Check out my Habitual Heart 50/20/30 Budget Template on Etsy for these equations built right in.
- 50% on Essentials
- Housing (Rent or Mortgage and insurances/taxes)
- Utilities (Internet yes, Netflix no)
- Groceries (food you need to live, not the splurges)
- Transportation (car, fuel, insurance, public transportation)
- Health (insurance and co-pay)
- Clothing (shopping sprees not included)
- 20% Financial Goals
- Debt (Credit Cards, Student Loans, etc. Mortgage and car payments included in Essentials)
- Savings (401k, retirement, investments)
- 30% Wants
- Dining Out
- Entertainment (Netflix goes here)
- Vacations
- Toys
- Treat Yo’ Self
- Gifting
Take It A Step Further…
Housing = 30% or Less
Housing is the largest expense for most people so it makes sense there are a couple of rules set up just around keeping housing costs manageable. Keeping housing costs at or under 30% is actually important for a couple of reasons. First, it helps ensure that you can afford other essentials, savings, and needs when you keep your largest cost under control. Secondly, when you are applying for a loan, this is one of the factors loan officers look at. They will check to ensure your future mortgage (principal, interest, tax, and insurance payment) will not exceed 28% of your income. If you can manage to have your housing costs below 30%, more power to you!
Another rule of thumb for home buying is that you should always aim to be able to puy 20% or more down so you can avoid PMI (Private Mortgage Insurance). This is an extra fee you will pay as you are a greater risk without 20% down. Along the lines of not purchasing more home than you can afford, the total cost of your home should not be more than three times your annual income and ideally closer to two or two and a half.
Transportation = 15% or less
Transportation can be pricy and the cost doesn’t often slap us in the face, it creeps ups in little ways. When calculating transportation costs you should take into mind car payments, maintenance costs, fuel, insurance, parking, and public transportation. Using this percentage puts some guidelines on what kind of car payment you can afford.
Retirement – 10% or more
Most financial advisors recommend putting 10% of your total income towards retirement savings (in the form of 401k, IRAs, or individual taxable accounts.) Ideally, this savings starts at the beginning of your career or around your early 20s, but that is not always the case. If you are getting started later you will have to increase that savings rate to meet your retirement goal. That being said, ultimately a generalized goal is to have 20x your annual income saved for retirement.
Given that income changes throughout a career, there is another rule to consider based on your goal retirement lifestyle. Members of the F.I.R.E. (Financial Independence Retire Early) Community follow the “4% rule.” This rule is based on 50 years of historical stock and bond performance that has shown you can withdraw up to 4% of your investments a year without running out of money for at least 33 years. People in the F.I.R.E. community aggressively save to get to their retirement goal, sometimes saving up to 50% of their income or more. However, the 4% rule can work for anyone saving at any pace and it’s an easy number to calculate.
25 x Expected Annual Expenses = Retirement Goal
While the F.I.R.E. movement is not for everyone, it has yielded the formula showing your retirement goal should be 25x your expected annual expenses. Working off a number that does not vary as greatly as income seems a little more realistic and it’s also an important reason to always have a clear picture of your overall spending.
Designing Your Budget
The beauty of a budget is that you can design it to fit your life. The rules above are just guidelines, but if the most important thing to you is that you live in the big city, close to work and you would rather spend money on the perfect place to live over travel or going out that is 100% your call. Make your budget work for you.
Do you have budget tips you live by? Make sure to share in the comments!
