Now that you know where your free cash is going—and I hope you’ll keep the exercise of tracking your spending going for the next few weeks or until you feel you have it under control—we can work on a budget in general.
I know how some of you feel about budgets. You feel they’re like diets—too restrictive—and that having to live under the guise of one takes away your freedom and individuality.
Point taken. It is a word that feels negative. I prefer the term spending plan. I want you to look at the money coming in and going out, to break it into categories consciously so that you decide how much you’re spending on everything from food to housing. And my end goal is to make sure that at the end of all that spending, month in and month out, there is at least 10 percent set aside for you to save.
So here’s the way to go about it. First, look at how much you’re bringing in each month. This includes your take-home pay and your spouse’s or partner’s as well as any other sources of income you might have. Do you run a small business on the side? Do you have rental properties? Do you sell old books on eBay? It all goes into the soup. If it varies, come up with the average monthly income over the past year. That will let you know exactly what you’re working with.
Then look at how the money is going out. Your bills for the past few months will give you a starting indication. But in general, I’d like to see a breakdown that looks something like this:
- 35% Housing: This is not just your rent or mortgage (first and second if you have both), but also the cost of insurance, taxes, utilities and maintenance (plan on 1 percent of the value of the place per year for the latter).
- 15% Transportation: Again, not just your car payment but taxis, parking, insurance and maintenance too. Also public transportation.
- 15% Other Debt Repayment: Credit card payments, student loan payments and any other debts you owe.
- 10% Long term saving: Money you put away for tomorrow – or many years from now. This includes money you funnel into emergency savings, college savings, retirement savings (including 401(k)s and other work-based plans). You can even include matching dollars if that gets you to the 10%. (Note: If you’re not sure where to put this money, this is where a financial adviser comes in very handy!)
- 25% Everything else: This is the cost of your life and it’s a good bet that most of the spending you were tracking last week goes into this category. Food, entertainment, clothes, cosmetics, travel and anything that doesn’t fit into the other categories goes here.
Once you see where your money is going, you can—and should—reallocate, particularly if it helps you get to that 10 percent saving figure. My basic rule is that you can borrow from any category to fund another except for saving. If you’re not spending the full 15 percent on transportation but want to spend a little more on housing? Fine. If you don’t have big student loans and want to spend a little more on a vacation, that’s okay too. And if you have the ability to save a little more than 10 percent at any particular time? Do it! There will be years when the responsibilities on your plate multiply. Anything extra you can do now will take the pressure off later.
Do you have a spending plan already? How is it working out for you?