Over the years (so many years) that I’ve been writing on Money After Graduation, I’ve left many posts about money basics back in the archives. Which is too bad, because I feel like over time, not only has my knowledge of more complex financial topics increased, but my philosophies and perspectives of the fundamentals has also expanded.
When it comes to budgeting, most people think of it in the context of managing their spending, and that is the purpose it will initially serve. But what if you changed your perspective to develop a budget where the goal was to make you rich? Below is an outline of the very basic budget, and how it should transform over time as you take control of your savings and debt. Remember, building lifetime wealth is a lifetime journey, so be patient with your progress!
What should my budget look like?
I get this question all the time, and the answer is simple: when you’re just starting out, your budget should look like this…
This is a great guideline to follow when figuring out what you can afford and how to allocate your money, and it’s exactly the chart I recommend in my downloadable Millennial Money spreadsheets.
For a detailed breakdown, here’s what the categories mean and include:
This includes all housing costs, from rent/mortgage to utilities and property insurance. Anything that goes towards keeping a roof over your head is housing! This should be 35% of your budget or less. If it’s more, you might be “house poor” and have to cut back in other categories to afford where you live!
This is all vehicle or commuting costs, from bus passes to gasoline for your car. You can elect to put your car payment in this category, or under “debt”. If you have more pressing debt, such as credit cards or student loans, I would keep your car payment under Transportation to create a balanced budget. 15% is the absolute maximum you should be spending on transportation; the lower the better! If your vehicle is costing you more than 15% of your net income, you should rethink public transit as a viable commuting option.
This is all Savings and Investing — and I mean ONLY savings! Things like saving up for a vacation or a new car are NOT savings, they are planned spending! You have to be really honest with yourself about what constitutes savings. If you have any kind of savings plan through your employer, feel free to count it in this category. Even if it’s taken off of your paycheque before it hits your bank account, it still counts! You should be saving minimum 10% of your net income, but the more, the better. If you are below 35% for housing and 15% for transportation, throw a bit extra in your savings!
This is all the payments you’re making towards any kind of debt, from credit cards to student loans. If you put in all your debt payments and find you’re below 15% of your net income, increase those payments — you can afford to! It is a good idea to choose cheaper housing and less transportation costs if it means you can put more towards debt. Always save at least 10% of your income, but after that, anything extra should be going towards your debt!
This category is everything else: cellphone bills to beer to clothes, plus groceries, gifts, and vacations. Whatever else you need to buy that doesn’t fit neatly in the above categories goes here. 25% of your net income should be enough to meet your needs. If you find you’re spending more than 25% here and you have debt or are not saving at least 10%, this is where you need to cut back to balance your budget. It might seem crazy to have a category that let’s you go to movies or have wine with friends when you’re in debt or saving for a big goal, but it is super important that you give yourself some breathing room in your budget! This will keep you from feeling constrained or trapped by your debt. It is good to throw extra money into savings and against debt, but leave some in your budget to take care of yourself too!
In addition to working with the budget above, you should be focused on the following 4 financial goals:
- Saving a minimum $3,000 in an emergency fund
- Start a retirement savings account (this should represent at least half of your savings!)
- Pay off all debt
- Reduce spending (the less you live on, the better)
These are essential for creating the foundation on which you will build your net worth. But what happens if your budget balances and you’ve already got a trusted emergency fund and your debt is all gone?
Start budgeting to build wealth!
After you’ve tackled the above, your budget needs a makeover to make you rich. Now it should look like this:
Now it’s only four categories, and one got really, really big.
This budget is NOT for everyone, because it is a challenge and if you’re just starting to get the hang of your finances, it can be intimidating. After all, this budget makes a few assumptions:
- You have no debt whatsoever, including no car payment
- You earn an income large enough that lets you afford housing in your area for less than 30% of your take-home pay
- You can save 35% of your income while still being able to pay your phone bill and buy groceries
I realize this is a big ask, but this is the budget that is going to make you rich. Perhaps you can even do better, and lower your housing and transportation costs further, or find you don’t need 25% for miscellaneous spending. Maybe your housing is too expensive in your area, but you can get your miscellaneous spending under 25% of your net income. All of these would let you increase your savings rate even further, which is the most important part.
For many, this will seem totally crazy.
Most people think they will have a car payment for life, or that they cannot save 1/4 of their income, let alone more than 1/3. And that is why most people will not become wealthy in their lifetime. But just because you cannot accomplish the above right now, doesn’t mean you never will. Use it as something to strive towards, and keep adjusting your budget as you go.
Eventually, the above can change even more dramatically. For example, imagine you choose not to have a car and walk or take public transit everywhere so your transportation costs drop to 2%. Imagine you pay off your mortgage in your 30’s or 40’s and your housing costs drop to 8% of your income. This would let you increase your savings to 60% (!!!) while also increasing your spending to 30%.
That doesn’t sound too bad, does it? I’d be down for bolstering both my savings rate and my wine budget!
The point is, your budget is flexible to the choices you make, and will probably change over the years as you make more progress with your finances. But the focus has to be building wealth, not spending. You cannot keep the mindset of upgrading to a bigger house every 5 years because raises in your job have given you more buying power. You cannot think a car payment should always be in your budget. You have to commit to getting rich!
The thing to remember is: it’s not easy
I’m not telling you to save 35%+ of your income or live without debt because it’s easy. It’s not. It’s hard to drive around an older car, or go without one entirely, when all your friends have financed new ones. It’s hard to decide to limit yourself from going out to dinner all the time or buying the clothes you want. It’s hard to say no to vacations. We have become so accustomed to funding our lifestyles with credit, you will look like you make half of what you do just because you choose to live within your means. Sometimes when you look at your savings account, you will only think about all the things you want that that money could buy, but you can’t have. It’s not easy.
You just have to remember that it’s worth it.