Budgeting Basics – Allocating $$$ Like a Boss
I know that I’ll probably be crucified for saying something like this, but I know I’m not the only one who feels this way. I also know that I’m a personal finance blogger and that the title of this article is “Budgeting Basics”, but it needs to be said:
I. Hate. Budgeting.
GOD that feels good to get off my chest. I know it’s a little unconventional to admit, but let’s call it out for what it is: budgeting sucks. It’s not fun to sit down and go through each one of your bills and realize that Amazon and Whole Foods basically own your ass. I know it’s hard to say no to free shipping and to organic mac n’ cheese, but something has to be done so that people can get their financial shit together without having to track every cent that you spend.
And therein, dear reader, lies the goal for today. I want to equip you with something that you’re going to be able to stick with, and that you’re going to be able to actually do in a timely manner. Time is of the essence here, and if you’re the person that’s not grabbing a drink with friends because you’re too busy tracking how to cut $0.37 from your entertainment budget, then this article is dedicated to you.
This basic budget is going to be split into 5 parts, which you could probably guess at this point:
There are some things that I want you to keep in mind as we’re going through these budgeting basics:
Monthly Post-Tax Income – The starting point for all budgets is how much money you plan on making. In our examples, we’re going to assume someone right out of college is making $3,000 a month after taxes. I KNOW SOME OF YOU MAY MAKE MORE OR MAKE LESS! But this article is really just for demonstration purposes. Just remember: your starting point is how much is put in your bank account by your employer (every 2 weeks or every month).
These Are Guidelines – These budgeting basics are not an exact science. In fact, I made this list purposefully NOT scientific. The harder you make it on yourself to budget, the less likely you are to stick to it. So, we’re going to make this REALLY easy on you with the expectation that you stick to it! But if I tell you to keep a cost to a certain percentage of your budget, and you’re a couple of percentage points over, the 4 horsemen of the apocalypse are not going rain down a hellfire upon you.
Budgeting Basics Rule #1 – Pay Yourself 20%
You might have found it odd that I put “Retirement” before anything else on the list. Is paying for retirement really more important that paying your rent?
My argument is: YES, it absolutely is.
Conventional wisdom says that you need to put 10% of your income away for retirement purposes. This personal finance mantra evolved sometime after man’s discovery of fire but before we started painting on cave walls. It’s been around forever! However, this site is called “The Code To Riches” not “The Code to Achieving a Moderate and Barely Respectable Amount of Money.” I want better things for you than 10% savings will allow. Let me hit you with some math:
If you start at $3,000 post-tax income, and every year you receive a 5% raise, when you save 10% of your income per month at 9% return per year you will have roughly $1.5 million to show for it after 35 years. Which sounds like quite an accomplishment; you’re a millionaire! Except that after inflation, that $1.5 million is actually worth $519,000. Yeah, inflation can be an absolute bitch.
When you double your savings rate, all of those numbers double. So you’d end with just over $2.9 million, and when adjusted for inflation you’d still be a millionaire, even in today’s terms.
Now, if you’re in a cushy job where you’ll have a government pension plan, or maybe a big corporate pension, then you might not need to save 20% every single paycheck. However, considering that millennials change jobs every 2 years, it’s necessary to be prepared to fund retirement yourself. 20% keeps you wealthy, 10% only helps a little.
So why did I put this first? Because your financial planning MUST revolve around you having enough for retirement. Unless, of course, you want to work until you’re 95, but I highly doubt that anyone reading this would want that. You can compromise on all of the other budgeting items listed, but if you try to compromise on your retirement fund, you will find yourself at the end of a VERY long journey with not enough money to do what you want. Maybe you live in a smaller apartment, maybe you don’t eat out as much, maybe you drive a cheaper car. But you MUST keep your savings at 20% if you wish to end up rich.
Budgeting Basics Rule #2 – Keep Housing at 30%
This is a very good rule of thumb for a number of reasons. First of all, keeping all your housing costs at 30% allows you to free up your budget for other things. Remember, keeping your retirement fund holy is IMPERATIVE if you wish to retire rich. But keeping your housing expenses down might mean more concerts, more movies, more vacations, etc. You’ll probably start to resent your super-expensive loft if you spend ALL your time in it because you can’t afford to go anywhere else.
The second thing will be super important later on down the road.
If When you decide that you want to buy a house, you will have to apply for a mortgage. The bank is going use your income as a way to gauge how much you can afford in a mortgage. They use a ratio called the “Housing Ratio” (10 points for originality, bruh) to evaluate your ability to pay your mortgage. Essentially, your mortgage payment should be less than 28% of your pre-tax income.
So what does this mean for you? Well, if you can keep your housing costs around 30% of your after-tax income, then you will already be used to doing that when you get a mortgage. And since the bank will require 28% of your pre-tax income, you’ll already be ahead of the curve. You’ve adjusted your lifestyle and have the habit of keeping your housing costs low! You must be a genius! (or read a particularly helpful blog…)
Budgeting Basics Rule #3 – Keep food at 25%
This is a pretty big bucket when you think about it, which is why I kept it at 25%. I promise I’m not calling you fat (and I hope you listen better than some of my ex-girlfriends when I say that). When I say “food”, I want you to include not just groceries, but every time you go out to eat, when hang out at bars/clubs with friends and get drinks, when you have a coffee date with that cute guy/gal you met at the museum (who the fuck are we kidding, you both swiped right and are just to timid to do the deed the first time).
If you’re earning $3,000 a month after tax, then that means you’d be spending $750 on groceries, eating/drinking out, and timid tinder-induced coffee dates. That’s quite a bit of money, as you should be able to keep your grocery bill down around $100-$125 bucks per week. This leaves $250-$350 to get all your drunken shenanigans in AND be able to pay for the coffee to nurse the hangover the next day.
This would also be where you would put “medical” expenses (anything you’d have to go to the drug store for). Though I have to say: this is a blog for millennials. Your medical expenses shouldn’t be a huge factor when you’re 25. Pop a couple Aspirin, drink some water, and buck the fuck up. Sleep when you’re dead.
I’m just kidding. Please take proper care of yourself.
Budgeting Basics Rule #4 – Keep Transport at 15%
You have two options: allow yourself to think that a pile of metal and four tires somehow demonstrates your value to society and how amazing you are, or don’t be an idiot and buy a cheap, reliable car. You can probably guess which way I’m leaning.
If you keep your transport costs at or below 15% of after-tax income, then you’re looking at $450 per month spent on getting your ass where it needs to be. If you’re talking about a car, that includes a car payment, insurance, maintenance, gas, and yearly registration (which can be ungodly expensive, depending on the state). That’s not a lot of money AT ALL to maintain a car. You’d probably have to have a car payment around $200 to even begin to think about making that work. If you’re going to go the car route, get yourself something safe, used, and awesome gas mileage. No one is going to be impressed by a young kid with a sweet car.
… well, they might be. But they’re just as stupid as you are for spending that much on transport. If I see you doing it, I’m going to throw my computer at your face till this blog post sinks in… because I love you and want good things for you.
The question that I’m sure a lot of you are asking is, “What if I don’t have/need a car?” The first thing I would tell you is, “AWESOME!!!”. The second thing I would tell you is that since you probably live in a major metropolitan area (NYC, Chicago, LA, Houston, etc.) there are probably lots of public transportation options available to you. I just looked up the 30 day NYC subway unlimited Metrocard, and it costs $116.50. You can make this work, boo-boo. Just use public transportation when it’s available. Your wallet will be glad you did.
Budgeting Basics Rule #5 – Keep Entertainment/Extra at 10%
Ah, finally. The part you’ve been waiting for. “How much can I spend per month on recklessness and debauchery?” The answer to that question is up to you my friends. Using our example from the beginning, 10% of your after-tax income is going to be $300. Now, that’s not a ton of money, but this is the entertainment budget. You don’t need to be spending money every week on entertainment, especially given that we’ve already allocated MORE than enough “eating/drinking-out” funds at Rule #3.
This is going to be the money you will use to head to the city to catch that Justin Bieber concert (I only judge you a little for liking him), or to save up so you can go to the fancy Mediterranean cruise you’ve talked about doing with your friends. Whatever your heart’s pleasure, use these funds to accomplish it.
I would be remiss if I didn’t mention the other thing you could do with this money: make additional payments to your retirement. I know, I know, it’s boring and no fun and you don’t see the returns immediately. What kind of millennial am I? But I think that most new graduates could afford socking away a couple extra hundred bucks a month. It’ll mean tens of thousands of dollars difference once you retire.
A Quick Note on the Rules of Budgeting Basics
Just to be perfectly clear, these rules are not like tee-shirts that you win from a radio contest: one size certainly does NOT fit all. These are rough guidelines to give you some sense of where you money should (and shouldn’t) be going. These rules are able to be bent ever so slightly; not broken till they shatter like the dreams of an American Idol contestant.
And if you didn’t notice, they do add up to 100%. So as long as you’re not going completely overboard with the bending of the rules, you’ll be ok. Maybe your apartment is 35% of your after-tax income, but you’re not as into food as, say, someone like me (as you could tell by my waistline). That’s OK! It’s fine to take from other parts of your budget, as long as you make up for it somewhere else!
Budgeting Basics – The Wrap Up
All right, so I made budgeting as easy to swallow as possible, but I know the word “budget” can instill fear in even the bravest of souls. Remember, if the thought of budgeting makes you want to tar and feather yourself till you look like a pissed-off ostrich, here’s all you need to remember:
- Pay yourself first! and put 20% away, not 10%, for retirement!
- Keep you living costs at around 30%
- Keep food costs around 25%. This includes restaurants, drinks, and coffee, you social butterfly you!
- Keep transport at 15%, though it should be WAY less if you don’t have a car. #bigcitylyfe
- Your extra should be no less than 10%, but the more the better (for Coachella AND your Roth IRA)
What budgeting practices have worked best for you? Are you the kind of person that enjoys the finer points of budgeting, or were these budgeting basics almost too much for you? Comment below!
Keep trying to crack the code,
Paul AndrewsFollow me on social media!