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How To Set Budgets

A better budget in three easy steps:

I get it, budgeting is hard, and while the 50/20/30 rule is great, it doesn’t work for everyone. If spending less and saving more is a resolution you struggle to stick with, a goals-based budget might help do the trick.

Here are three steps to kick your 2022 savings plan into high gear:

1. Set some goals.

Firstly, it’s critical to understand what’s important to you. Are you striving for a long-term goal like financial independence? Maybe your goals are more immediate and revolve around becoming debt free or taking a dream vacation. Or maybe it’s important for you to save and help pay for your child’s education. Whatever your goal(s) may be, set a specific timeframe to achieve them, and write them down. Researchers say you’re 42% more likely to act on your goals if you write them down.

2. Track where your money is going.

It’s important to have an understanding of where your money is going currently if you’re going to enact some changes. It’s hard to save if you don’t know how much you are spending. To get started, first gather all of your financial statements for your credit/ debit cards and checking accounts over the last six months. Take a monthly average of all of these outflows to get a good picture of how much your variable expenses are (ex. eating out, bar tabs and shopping that changes each month). This way you have an objective measure of all the items you have been buying instead of measuring an amount going forward when you know you are keeping tabs.

3. Make your budget.

  • The stuff you need: Out of all the money that hits your checking account, a majority of it goes to the things you need, like housing, food, and transportation. There’s a good chance most of these costs are fixed, but there may be some opportunity to free up some space in your budget by cutting back on eating out or reexamining your priories as it relates to where you live or what you drive.
  • Goals: These are the things from step 1 that you want to direct more of our hard earned money towards. Maybe you’re already directing some dollars toward monthly savings or making payments on student loan debt, but we want to direct more to this area. After all, these are the things you want to achieve and most valuable to you!
  • Other stuff: These are the things that we don’t necessarily need or want, and if you’re like me, they usually get delivered to my front door. It may be tough to part with some of the spending in this category, but you also have to ask yourself what’s really important, your beloved streaming service or a down payment for a new home.

Is there any ongoing savings ability based on this amount compared to your after-tax pay?

While budgeting is very important for setting yourself up for longer term financial success, I personally get no pleasure out of scrutinizing every minor detail of my personal expenses. Establishing buckets for expenses like travel, food, utilities, gifts etc. and then trying to live within a set amount for each category each month feels like way too much work and for me it makes spending money stressful. I personally prefer monitoring three separate equations for main spending goals including retirement savings, home mortgage costs, and overall debt servicing costs. Then as long as I stay within those three guidelines then I can spend whatever money is left however I please. No more worrying about how much I spent on restaurants in any one month as long as the overall spending goals are still in good order!

The first equation revolves around retirement savings.

Almost everyone wants to stop working at some point, and even if you are one of those people who claims to want to work until you die you still need to be prepared to retire based on a physical or mental inability to continue working. Our young professional investor education website Young Money, Smart Money, which is sponsored by Parsec Financial, outlines a projection of how saving 15% of your pre-tax income for retirement, and investing those savings wisely, will get you to a strong retirement position after about 36 years. If you want to hang it up before then you should shoot for a higher savings rate, but keeping 15% as a minimum savings goal is a good starting point. For more millennial advice, download our whitepaper on eight saving and investing principles for young investors.

Second is maintaining a sustainable cost for your home relative to your income.

Take your monthly mortgage payment and add to that property taxes and insurance (if these are not being paid through escrow) as well as any homeowners or condo association fees. Altogether, these amounts should be below 28% of your monthly pretax income. If you are looking at moving and the new home will push this figure above the 28% level then you should reconsider making that move or look for a lower cost home.

Last is looking at your overall debt service.

Add any monthly student loan or car payments etc. to the monthly housing cost figure we just calculated. Make sure to keep this overall amount less than 36% of your monthly pre-tax income. If you want a new car but the new loan payment will push you above the 36% level then you should keep your current ride, pay off your student loans before upgrading, or go for a lower cost vehicle.

If all three of the above figures are satisfied then you can calculate the dollars that you should have in take home pay after retirement savings and debt service. That amount is your lifestyle spending budget – so spend it as you would like! But, you will need to plan in advance for any bulk expenses so you can satisfy those as needed and your normal monthly spending habits can continue.

If you have added goals like college savings for a little one then you will need to siphon off say $500/month from your lifestyle spending amount so that goal is covered. If one or all of the above metrics are not satisfied then it is time to go deeper into your spending habits to start making tough spending decisions. Can you brew your coffee at home or take lunch to work? Do you need to go to that additional happy hour this week? Do you really need to go to your third bachelor/bachelorette party in one year? Or potentially look to obtain a graduate degree or professional certification that can help boost your income opportunity to help get the equations back in line over time.

Successful young investors will be saving close to 15% of their pre-tax income towards retirement if their employment situation allows it.

See what fat you can trim from your budget you just made to see where you can save! Also, plan for expenses you know are coming in a few years (home improvements, major vacations, children, etc.) and make adjustments as early as you can so you are able to maintain your savings level.

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All information included in this page and all pages throughout Young Money, Smart Money is provided for informational and educational purposes only and should not be taken as investment advice or a recommendation to invest accordingly. Investing involves risk, including a potential for a loss of principal. Educate yourself about all investments and funds you purchase, including their risks, objectives, and fees and expenses before investing. For additional assistance, please contact us or another financial professional for a more detailed review of your specific situation.

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