Alright my generation y-ers. Most of you are post college, maybe even for a few years now, or you bypassed college and went straight into the workforce. Whatever it may be, you’re living that adult life now. It’s nice to finally be bringing home larger, full-time working paychecks. But don’t be tempted to just blow your money on payday. You’ve got bills to pay and savings goals to fund! One of the most important things you can do for yourself is get into the habit of budgeting.
Why set a budget?
- Budgeting helps you spend less than you earn by tracking your spending habits and setting goals for yourself.
- Want to pay off credit card debt or student loans? Have a vacation you want to take but need to save up for? Budgeting helps you achieve your goals by figuring out how much “extra” you may have each month to throw towards debt payments or beef up a savings account.
- It’s eye opening to see where your money is actually being spent and might help you tweak those bad spending habits.
- Not knowing where your money is going leaves you vulnerable to overspending and living paycheck to paycheck. It will help you cut out that unnecessary stress.
I realize budgeting and numbers can be paralyzing to some, so we are going to keep it simple. One of the most basic ways to budget is to follow the 50/20/30 rule. I don’t think this rule will work for all, but it’s a great place to start and will work for most (especially for my beginning budgeters). The rule goes: 50 percent of your take-home pay should go towards “essentials” – things you absolutely cannot live without (food, shelter, etc.) 20 percent of your take home pay should go towards “financial obligations” – sure you could live without these things and it’d be great to not have to pay them, but they’re called obligations for a reason (retirement savings, emergency savings, debt). 30 percent of your income should go towards “personal choices” – this is discretionary and will be different for everyone (cellphone, internet, gym membership).
Essentials – 50% of your income
What are your absolute, can’t live without, essential needs? Your rent or mortgage, food, utilities, transportation. I view 50 percent as a cap, and I would hate to see anyone pushing this number. 50 percent puts you at “okay I still have money to do other things I want, but I’m not in over my head yet.” I think 50 percent is a very reasonable number. These essentials tend to be your larger expenses so it makes sense that they’d eat up half your income. Personally, I keep my car payment under essentials and not financial obligations. Yes, this is technically a debt payment but I consider my car an essential since I need it to get to and from work. You could put your car under financial obligations if that helps you stay under the 50 percent cap for your essentials as well.
Financial obligations – 20% of your income
This 20 percent will mostly consist of your savings and debt payments. I like to think of 20 percent as a minimum here, paying or funding financial obligations will only benefit you in the long run. Increasing monthly savings or paying down debt with additional payments will help build your net worth. So if you have some extra money left over from one of the other categories, consider allocating it to your financial obligations.
For most, retirement contributions come out of your paycheck pre-tax. So these contributions wouldn’t be included in your monthly budget. Now if you make contributions to a Roth IRA or a Traditional IRA on your own after taxes, then I would include those contributions here. As mentioned above, some may or may not put their car payments as a financial obligation. Or, maybe you put your minimum car payment under essentials and anything extra you pay can be allocated to financial obligations.
Personal Choices – 30% of your income
These are our wants, and you should allocate up to 30 percent of your take home pay to this category. The expenses in this category are going to be different for each individual since we all have different interests, hobbies, and priorities. Expenses in this category include cellphone and internet (yes these are technically wants not needs!), gym membership, streaming services, entertainment, dining out, your daily Starbucks.
How to get Started:
Remember, the key to budgeting is spending less than you make.
Most budget on a monthly basis. Since people are typically paid biweekly or bimonthly and your bills are frequently paid on a monthly basis, it makes sense that you would budget monthly.
Step 1: Figure out your monthly take home pay. This is usually what is direct deposited into your bank account, your wages less any taxes and deductions. Using the 50/20/30 rule, determine how much of your take home pay should be allocated to each category.
Step 2: Gather your last 90 days of transaction history from your bank account and/or credit card (whatever you use to make purchases). You can either print statements or most banks will let you search for specific transactions and you could get 90 days-worth that way.
Step 3: Find three different colored highlighters (let’s say yellow, orange, and pink). I want you to go through your last 90 days of transaction history and highlight in the following way:
- Yellow will be designated for essentials
- Orange will be designated for financial obligations
- Pink will be designated for personal choices
Be honest with yourself here. This will be eye-opening to see how much of your spending is actually necessary and where you might need to rein it in. It’s easy to mindlessly swipe your debit card everywhere you go, I don’t think it really impacts you until you see it all on paper. Every single transaction should be highlighted when you’re done with this step.
Step 4: Total all of your categories up and see what you’re spending on average on a monthly basis. Does this fall into the 50/20/30 guidelines? If not, can you tweak your spending? Maybe this will help you determine where you can cut back in certain categories. You might come across irregular bills at this point (your non-monthly expenses such as auto insurance), average these payments out to a monthly dollar amount.
Step 5: Create your budget. List out your recurring expenses under each category. I’ve included a snapshot of an example of what your budget may look like. One thing that is important to do is allocate every single dollar of your paycheck, every dollar needs to have a purpose. Layout wise, do what works for you. Handwritten may work for some, others may like to nerd out and excel it. The following example shows the 50/20/30 rule in excel format.
Of course this is just an example of a budget, but it gives you a general idea of what the 50/20/30 rule looks like laid out. Obviously tweak the expenses for your own needs. Since budgeting can be overwhelming, feel free to use the contact form below to send me any questions you may have.
Carolyn Rowland is a CERTIFIED FINANCIAL PLANNER™ passionate about empowering individuals to take control of their financial landscape. “We often tend to place our own priorities on the back burner for others, resulting in sacrifices we don’t often realize we’re making.”Carolyn believes in taking a values-based approach to financial planning. “Together we’ll define what matters most to you, what you want your life to look like, and develop a plan that fits your lifestyle.”
Carolyn Rowland is in the Milwaukee WI, area.