Money is like life — it’s what we make of it. For every person with a $2,000 paycheck, most of it spent within a week, there’s another person with the same take-home pay who stashes the majority of his $2,000 in a savings account: two sides of the same financially irresponsible coin.
Then there are those who take their $2,000 and find the most perfect balance of spending and saving. These people have no debt, live within their means and have funds left over at the end of each month. They’ve learned how to budget properly.
Different financial experts give different suggestions for how we should divide up our paychecks. Should we set aside 50 percent for rent? And 15 percent for food? Or 100 percent for transportation? Do our wants or needs come first, and how do we quantify them?
In this next installment of our paycheck series, you’ll find there’s no concrete rule to setting a budget — but finding the right plan for your finances will make all the difference in the last few days before that next paycheck comes through. Keep reading!
1. Divvying Up Those Dollars the Jean Chatzky Way
We can get by without many of today’s amenities, but we all need a home. Common financial advice maintains that you should be saving roughly one-third of your paycheck towards housing — that can include rent, mortgage, home insurance, maintenance and taxes.
Some recommend 30 percent; Jean Chatzky of NBC Today, on the other hand, says that 35 percent is more like it. Either way, this is where a large chunk of your income should be used.
Likewise, experts advise setting aside anywhere from 10 to 15 percent for transportation — car payments, gas, insurance — though up to 20 percent is recommended by agencies like the Credit Counselling Society (CCS).
You should also be devoting 5 to 10 percent each to saving money and repaying debt, with another 15 percent toward clothing, entertainment and miscellaneous expenses. The CCS is even more specific on this point, saying that 3 percent should go to medical expenses, no more than 5 percent to clothing, and discretionary spending shouldn’t exceed 10 percent.
Chatzky recommends budgeting no more than 75 percent of your pay toward all of your expenses, leaving 25 percent for miscellaneous or flexible spending/saving.
Here’s a recap:
- Housing: 30-35 percent
- Utilities: 5 percent
- Transportation: 15-20 percent
- Savings: 5-10 percent
- Debt repayment: 5-15 percent
- Food: 10-20 percent
- Clothing: 5-10 percent
- Medical: 3 percent
- Discretionary: 5-10 percent
2. Elizabeth Warren’s 50-30-20 Rule
It’s called a rule, but it’s merely just a customizable budgeting guide. The 50-30-20 rule takes your after-tax pay and divides it into three categories for needs, wants and savings. The plan was created by Massachusetts Senator Elizabeth Warren and has been touted by Liz Weston for its simple financial efficacy.
Following the 50-30-20 rule involves a few simple steps:
1. Begin with your after-tax income. This will be the net pay listed on your pay stub, after all deductions have been made (like taxes, 401(k), health insurance, etc.).
2. “Needs” are limited to half, or 50 percent, of your income. Needs/must-haves include the expenses you cannot skip, like rent. mortgage, utilities, car payments, auto insurance or food.
3. “Wants” get 30 percent. Weston qualifies vacations, gifts, entertainment, clothes, eating out and other leisurely spending pursuits as wants, or things we can mostly do without. She clarifies that there is some overlap; whereas a cell phone bill is a need, an unlimited/long distance plan, for example, is a luxury.
4. 20 percent is saved and/or used to pay down debt. It warrants the smallest percentage in the 50-30-20 breakdown, but in this author’s opinion, it’s more important than spending on wants. Here, 20 percent is designed for short- and long-term saving, for emergencies, tuition, future housing purchases or retirement, as well as reducing debt.
“To achieve financial independence and minimize the chances of disaster, you need to get rid of consumer debt, save for retirement and build your emergency fund,” Weston explained on MSN Money. “Any loan payments you make above the minimum belong in this category, as do contributions to your retirement and emergency funds.”
GOBankingRates writer Jennifer Calonia cautioned that the 50/30/20 rule is a malleable structure. “Elizabeth Warren’s rule is at its root a guide,” she wrote. “Ultimately, you have to make choices in how you categorize each purchase so that none of your budgets are exceeded.”
100 Percent Budget-Friendly
And that’s why both of these plans work. They’re not a set of hard-and-fast financial laws, rather a pair of useful money management tools designed to be modified according to your needs.
By learning how to budget according to the pros, you’ve laid the foundation. Now, by using the tips in this article as a template, you can adjust the amount you allow weekly and monthly to your own expenses.
It could be 25 percent toward housing, or 20 percent to saving. Tweak the numbers and see what works for you. Soon, you’ll find the perfect fit according to your income and the cost and amount of your revolving expenses.
Weston warned that some trial and error is inevitable, and it won’t take overnight to reach that financial goal. The easiest costs to adjust, she noted, are food, utilities and transportation.
“You may be discouraged by how far you are from the ideal. But running the numbers can help you understand why your money isn’t working for you,” Weston wrote. “If basic overhead consumes so much of your paycheck, it’s no wonder you have trouble saving, paying off debt and living the rest of your life.”
By following one of these two plans, you’ll be able to stop wasting money on things you can’t afford and have enough saved to buy what you want and need.
And that is what financial freedom is all about.