I’ve mentioned our current budgeting strategy a couple of times, but I’ve yet to go into the details of how it works. Today it’s time to remedy this.
We have tried a few different budget plans, and they all worked ok, but we felt like they were lacking something. The goal of most budgets is to make sure that everything adds up at the end of the month so that you don’t end up spending more than you make.
We dutifully created our little budget spreadsheet. We added up all our expenses. We subtracted those expenses from our income. If our income was more than our expenses then were on track.
This method felt like it was lacking something. We were missing some underlying guidance. For many years we went on with this hole that made our budget feel incomplete. I had no idea what this hole was until I read “All Your Worth: The Ultimate Lifetime Money Plan.” In this book the authors recommend a strategy that tells you how much money you should be spending in three categories.
That was it! I had my budget, but I had no clue how much we should spend on needs, wants, or savings. The only advice I had heard about how much to spend was the traditional “spend 25% of your income on your house/rent.” That advice was incomplete. After I read “All Your Worth” I had a better idea of how much money we should be spending. It changed my simple budget into a more solid financial plan.
50% on Must Haves
For the first time in my life, I had some guidance on how much of our income should be dedicated to our Needs. Must Have items are basically Needs, but also include any monthly contract payments that we have entered into. You might also think of these as “Must Pay” items.
This includes Mortgage/Rent, Utilities (power, water, sewer, gas), Groceries, Car Payments, Gas for your commute. It also includes payments to wants that you have entered into a contract to pay. These items typically have some type of fee to break the contract. Things like cell phone plans and gym memberships fall into this category. You might think of it like this… If you stopped paying, these folks would be knocking on your door expecting payment.
Add up all the items that you Must Have or Must Pay. That number should be equal to or less than 50% of your take home pay.
30% on Wants
Ahhh, the fun stuff… Wants. Wants are everything that you want to spend money on. Eating Out, Movies, New Computers, Toys for the Kids, Toys for us. This also includes that Cable TV bill and any monthly recurring payments that aren’t under contract.
20% in Savings
I’ve read the average American saves about 5% of their paycheck. This number includes 401k, which is typically automatically taken out of your paycheck, meaning we’re basically saving almost nothing. I read another article that says Americans save an average of $392 per year. No matter how you slice it, most of us are not good savers.
We were horrible savers when we owned our own home. It seemed like most of our money went toward needs and maintenance, will a little left over for wants, and nothing left for saving. Now we have a rule that says to save 20% and we are doing much better.
Savings can be saved for any purpose. Typical savings are for retirement, college, and emergencies, but you can also use savings for other future spending. You could save for Christmas gifts, a new car, or a vacation. Some of those things seem like they are wants, but when they are expensive wants, it’s ok to save for months or years before converting it from Savings to Wants.
The challenge for us was to get our Must Have expenses down. We were around 80% for must haves. Our mortgage was the same as what we are paying in rent now, but in addition to that we had a second mortgage, high utility costs, and more maintenance costs. After selling the house and moving into our apartment, our Must Have expenses float around 50%.
It seems to me that the majority of people I know likely have a Must Have problem. I see many people living in houses or renting apartments that place them much higher than 50% in Must Haves. In “All Your Worth” they also found some people with Wants problems. Most of these were shopoholics. I think most of the examples were from people that were simply buying too much stuff.
There are a number of benefits to living according to the 50/30/20 plan.
Security. One of the biggest I can see is security. By keeping Must Haves below 50% you are better able to handle some of the challenges that life throws at you. If you find yourself laid off, you will have an easier time because of your low Must Have expenses and your Savings. Unemployment plus Savings will stretch further when your Must Haves are reasonable. When I was laid off a few years back, I had a very hard time getting our monthly spending down. Even though we were eating cheaper and packing sandwiches whenever we went out for the day, money was still flying out the door to pay for our expensive Must Haves. If this were to happen to us today, even though we are renting, we would be in a more stable financial position.
Wants in check. One of the problems with many budget plans is they don’t give you a clear idea of how much you can spend on wants. Wants are where we find enjoyment in life, and without setting a clear limit it’s easy to overspend in this category. Have the limit makes it very easy to see if you are living within your means for your fun expenses.
Forced savings. Keeping the wants in check has also helped our savings. Before we downsized to get our Must Haves below 50% we had no room in our paycheck for savings. All our money went towards Must Haves and Wants. I did have a 401k saving 5%, but that’s not enough. Now that I have money to save, I opened a few savings accounts and automatically distribute money into these accounts from every paycheck. My online banking has the ability to schedule transfers, so I scheduled money to be transferred on payday from my checking account (where my paycheck gets deposited) to several savings accounts that I allotted for different purposes. We have a general savings account, an emergency fund account, an account for our daughter, and a car fund account.
Living below your means. This is a combination of all the above benefits. It’s nice to have a plan to live below your means. Money isn’t always a hot topic anymore. We feel like we have enough money now to cover everything. We no longer live paycheck to paycheck thanks to this plan. We easily cover our Must Haves and have plenty left over to create fun and memorable experiences. It feels great to live below our means for the first time in our life.
Does this budget work for everyone?
The one question I had after reading All Your Worth was, “Does this work for everyone?” The authors claim it does, but I wonder how it works for someone on minimum wage. In my state minimum wage is $7.67 per hour. This averages to $1329.46 per month (not accounting for taxes), meaning that must haves would need to be below $664.73 per month. That seems almost impossible. But the more I think about it, the more I realize that many people feel entitled to live the high life even though they don’t have the income to back it up. It’s a hard reality to face on minimum wage, but I think it is possible. You have to find affordable housing and maybe even get a roommate. Annie, at annienygma.com, lives on less than this, so I know it’s possible.
For us, we are making an above average salary, and it seems almost inconceivable that we would have to downsize so drastically to get our Must Haves below that 50% mark. Perhaps we, as a country and maybe even as a planet, need to adjust our expectations. After adjusting for a short time, we’ll realize that we really can’t afford the huge house we want, or maybe it even makes more sense to just rent. I imagine it might be a shock to many people to try to adjust to this 50/30/20 budget. It was a shock to us.
Where do weigh in on this?
If you are already within range on this budget, how do you feel financially? Do you feel stable?
If you aren’t within range on this budget, what do you think of it? Which category are you over on? What would it take to get on budget in that category?