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The Bureau of Labor Statistics (BLS) finally released its 2012 Consumer Expenditures a few months back.  I find this report interesting, albeit fairly esoteric.  It’s interesting to see, for example, that spending on “Vehicle Purchases (Net Outlay)” increased a whopping 20%.  Health insurance costs have increased 13% since 2010.  And the average American certainly doesn’t set a good example, spending as much as he earns after taxes.

So, the question of the day is: “What’s the ideal way for me to allocate my spending?”

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If you don’t already, start by tracking your spending (recall I like to use the “Three Card” system I outlined in Mindful Spending).  It’s good to know what you have going on, ideally over the course of about three months, to get an average of what may swing from month to month.  You have to know where you’ve been before you can decide which way you need to go.

Maybe it’s a targeted amount of savings each month, maybe it’s just a percentage reduction in spending overall.  You decide where you want to be.  If you don’t know where to begin, one popular rule of thumb is “50/30/20.”  I didn’t invent this, but it certainly fits well with the “Three Card” approach.  It is simple and flexible depending on your life.

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  • Up to 50% of your after-tax take-home income is for necessities.  This is a roof over your head and clothes on your back.  This would include housing (don’t forget real estate taxes and homeowners insurance if you’re considering buying), utilities, basic clothing, transportation to work, some form of (at the very least catastrophic) healthcare insurance, childcare while at work, and groceries.
  • At least 20% is for your financial security.  Think of this as “paying yourself.”  This is long term savings, any additional retirement savings not withheld from your paycheck (you should max out your 401k), and/or  rainy day, need-a-new-roof savings.  Debt payments would theoretically go here as well, if you have pesky student loans or a car payment, for example.  Although, I would put any car payment above absolute necessity in the next “wants” category (you can see my monthly payment calculator here).  This is what you get to keep of your hard earned money.
  • No more than 30% is for “wants” (e.g. my Amazon card in the 3 card system outlined in my Mindful Spending post).  These are discretionary expenditures … as in, you have control over them.  These can be fixed (cable, gym membership) or variable.  I have heard these sometimes called lifestyle expenditures.  Cable, movies, restaurants, extra babysitting, shopping, swim lessons for kids, etc.  These are the last priorities in your budget.  But the beauty is, as long as you have stuck to the first two categories, you will feel more satisfied with the purchases that fit in this category, knowing you have paid yourself first.

Before you make any big financial commitments, at least plug in the information you’ve gathered to see how your spending would measure up to this guideline (aka a “sanity check”).  I sat down with a spreadsheet and did this when we were home shopping, and again when my husband was considering taking a new job with a different compensation structure.  I have also run this spreadsheet to see what it would look like without my income (and thus less childcare).

And don’t forget to account for every cent.  If you have some left over (bless your heart), it goes to paying yourself.  And make it automated.

For example, a 50/30/20 budget for the average American household (per the BLS) with income of ~$65,000 (with no childcare), may look something like this:

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How do I measure up personally?  The last few months I’ve been running at approximately 65/15/20.  Definitely not perfect.  Working to get better over time.  To be honest, this year is the perfect storm of childcare – 3 kids needing full time care.  Hence I won’t be getting that new set of dishes I’ve been eyeing anytime soon.  And I’ve been trying to avoid setting foot in Target or HomeGoods like the plague.  But, I am happy to report the lunch share has helped significantly with the little restaurant budget (I used to grab lunch out quite a bit).  Baby steps.

Special Situations

D.I.N.K.  If you don’t yet have children (Dual Income No Kids), this is your time to focus, focus, focus on raking in the savings!  If there may potentially be a “kids” scenario, the best advice (while not fun) is to run a few different spreadsheets.  First, look at what your budget would look like on one income.  You don’t have to necessarily live on one income while you’re still working, but any new FIXED expenses (i.e. new house) should fit with this potential scenario.  Second, run it with two incomes, assuming you will stay working … but here’s the catch … research childcare in your area to find how much room in your post-baby budget you will have for a mortgage (FYI – my childcare expenses are larger than my mortgage payment).  See what would be left in the room for housing and food.  Yes, this may mean you don’t get your dream house (at least not yet).

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See more drool worthy pictures of my dream house (aka Diane Keaton’s house) here or here.

I got a big raise, now what?  Look at your raise vs. inflation.  Your expenses are likely creeping up as well.  Before you increase any fun spending, increase your pay to yourself, then the extra can go to housing and fun.  Maybe take an extra vacation next year.  But whatever you do, continue to evaluate potential scenarios (job change, lost job, etc).  The last priority thing to increase would be any FIXED expenses (i.e. don’t run out and buy larger home, a new vacation home or a fancy car that requires a monthly payment).

The I-Just-Am-Cheap-About-Everything Person.  Maybe this is you.  Some people just try to spend less on everything.  I personally don’t like that method, because I feel it is too restrictive and stressful.  I think there is a balance between saving money and enjoying life.  If you structure it right, and stick to your goals, you can ENJOY the fun money you have left over and not feel guilty about that pedicure or new purse, or my favorite … a vacation.  If 50% of your income is covering the necessities, and you are saving enough, then I think you have every right to have fun and spend a little!

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Tuscany via here

There are a million more life and family situations, on both extremes, that make these guidelines irrelevant.  I cannot even imagine what it is like to try to support a family on minimum wage.  To only allocate 50% to necessities would be extremely difficult in most major markets (even with SNAP benefits to cover some food expenses).  Likewise, if you are a bazillionaire, you are hopefully spending way less than 50% of your income on essentials and hopefully you are saving and investing much more.  No matter what, these things are universal … build a budget, and re-evaluate it continually as life changes.

And of course, continue to practice Mindful Spending!

Laura Sig

 

 

5 Comments on How to Build a Budget

  1. Great tips. It’s so easy to loose track of where your money goes. I worked with money in my previous life and I’m sure I sounded like a broken record when I advised my clients to live within their means.

    On another note, love Diane Keaton’s house. I believe she had/has an extensive Maynard Dixon collection and she lent it all for an exhibit in southern California several years ago. Big fans, my husband and I made a special trip to see it. I can see now how wonderfully her home would have showcased Dixon’s work, wow!

    • Isn’t it beautiful? I can only imagine the Maynard Dixon collection would have been incredible in there – with the Spanish Colonial feel, exposed beams, and beautiful adobe colors, etc. The house was purchased sometime in the past year or two by Ryan Murphy (writer/producer and fellow Hoosier) who loved her style and actually kept a lot of her touches.

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