The best budgeting rule of thumb
Everyone is different. Personal finance is personal. There is however some general rules of thumb that work well when it comes to creating some good savings habits and maintaining a good budget. Let’s take a tour of those and I’ll offer my take.
The 50/30/20 Rule
- 50% of your net income goes towards needs.
- 30% of your net income goes towards wants.
- 20% of your net income goes towards savings and debt repayments.
Popularized by Harvard bankruptcy expert Elizabeth Warren, she suggests this approach will provide an appropriate level of balance with your money.
- 50% needs include rent/mortgage, groceries, utilities, insurance and other essentials.
- 30% wants may include travel, dinner out, events, festivals, other.
- 20% savings and debt repayments also include emergency funds and retirement savings.
I like this rule because it is simple. You don’t need much work in the form of a spreadsheet to figure out where all your money should go.
The problem I have with this rule is I believe it’s difficult for most adults to distinguish a want versus a need. The lines are blurred between the 50% and the 30%. I need a car to get to work efficiently each morning. More than one of my fellow co-workers has suggested in recent months I get a new car – after comments to me in the parking lot such as “that thing still runs?”
Yes it does.
What might be a need for someone is a want for someone else. Clothing is a need. Maybe some nice clothing is a need. Lots of new clothing every week is a want. You get the idea.
What would I suggest instead?
The best budgeting rule of thumb – just save 10% net income (or more) and never stop.
Simple. Just save 10% (or more if you can) of your net income every month.
Effective as well.
Start saving early. Keep saving. Don’t stop. Then you figure out what you can afford from there.
What you can afford from there probably includes:
- Short-term debt obligations
- Dinner out
Start with your net income, calculate 10% of that, siphon that 10% into savings and long-term investments, and don’t ever spend it until decades from now. That’s it.
The beauty of this plan is you don’t have to worry about messing up needs with wants. You don’t have to worry about finding 20% savings amongst everything else. As David Chilton so nicely popularized it years ago “just pay yourself first” and everything else will fall into place.
You can do this by setting up automatic bill payments or transfers to your savings accounts or investment accounts each week or month. You can decide what to invest in later. If you’re a newbie to investing, you can check out this post.
The saving “more if you can” comes in if/when you get a bonus from work, as your income grows over the years, as you reduce various expenses in your life like mortgage payments or car payments, and so on.
Saving 10% off your net income means you get into the habit of stashing the cash.
Assuming you start with $1,000 in the bank, and your net income is more than $30,000 per year throughout your career, $3,000 per year saved for 40 years at a modest 6% rate of return will create a portfolio more than $500,000.
As long as you pay yourself first, and you continue to do so for decades on end, your budget will stay nicely intact and you’ll have a tidy nest egg to retire on far sooner than most.
What’s your favourite budgeting rule of thumb?