Rules To Follow When Crafting Your Budget
A Few Budgeting Rules Of Thumb
Look, I get it. Sticking to a budget is tough. It’s even tougher when that budget isn’t grounded in the reality of your expenses in the first place.
How do you decide how much to spend, and on what? Here are a few budgeting rules of thumb you can follow to get yourself started.
No, these won’t necessarily work for everyone and every financial situation. They’re just rules of thumb. But they’re a great starting point in developing your personal budget.
The 50/20/30 Rule For Expenses
We’ll kick things off with probably the most cited budget rule out there. The 50/20/30 rule says you should spend 50% of your take-home pay on necessities, 20% on savings and retirement, and the remaining 30% on non-essential expenses.
What makes this rule of thumb so powerful? Well, its simplicity for one thing.
Easy To Learn, Difficult To Master
Building a 50/20/30 budget is really easy to explain as a high-level concept, which helps with its popularity. You just figure out your take-home pay, then divide your expenses accordingly.
Note, this is different from your gross income. Your take-home pay is how much you actually have to spend after taxes, fees, and other deductions.
Of course, this budgeting rule definitely has its drawbacks. It can be tough to implement in reality and a pain to track, especially depending on your unique income and expense situation.
Deciding What Is An Essential Expense
The 20 part is easy. 20% of your take-home pay should go to saving, including funding medium-term goals and saving for retirement. Personally, I like 10% going into retirement funds and 10% going into savings for financial goals.
The big trouble with this budgeting rule lies in the 50/30 divide. How do you decide what is an essential living expense, and what is “fun money?”
The easiest way is to ask yourself what you’d still spend money on if you lost all your income tomorrow. Chances are when you go with that line of questioning, you won’t categorize Netflix in the essentials category.
The 20/4/10 Rule For Buying A Car
We all want to drive a shiny, fancy car with all the options. Leather heated seats, heated steering wheel, premium suspension, self-driving, the works. (No? Just me who fantasizes about that last one?)
But your car purchase shouldn't wreck your budget. The 20/4/10 rule can help you determine how much car you can afford.
It goes like this: a 20% down payment, financed over no more than 4 years, costing no more than 10% of your gross income. This limits your debt and your savings hit.
Don’t Let Sticker Shock Scare You Off
A 20% down payment on a car can seem like a ridiculous amount. In general, you can get an auto loan with very little, or maybe even zero, down if your credit is good enough.
But there’s a really good reason for having a 20% down payment, especially if you’re buying a new car: depreciation.
When you drive that car off the lot, it instantly loses a big chunk of its financial value.
If you didn’t budget properly and put enough down on your car purchase, you could end up with a higher loan amount than the car is worth. That will hurt your credit.
Humble Your Car Dreams
Your yearly transportation costs should be less than 10% of your gross annual income. This includes your loan, gas, maintenance, insurance, and every other cost.
The only way to get there is to really crunch some numbers. Look at your budget to determine how much car you can afford. It’s probably a lot less than you originally wanted. Make sure you factor in those insurance costs.
When you force yourself to come up with 20% down and pay no more than 10% of your income for the next 4 years, you’ll find you significantly narrow your pool of potential new cars.
Consider going used, and always make sure you buy a car you can see yourself driving for the next decade. That's the best way to make your car make financial sense.
The 28 Percent Rule For Housing
If you’re still reading at this point, I know exactly what you’re thinking.
“What?? No catchy 3 numbers separated by slashes?”
But in all seriousness, this rule acts as a sort of guide to help you make sure you’re sticking to the first budgeting rule of thumb.
The 28 Percent rule says that your monthly housing costs -- mortgage, property taxes, and insurance -- should not exceed 28% of your gross monthly income.
We All Gotta Live Somewhere
Housing will most likely be your single largest fixed expense. Whether you rent or buy is up to you, but will also depend on what where you live and all the other pieces of your financial puzzle.
If your housing costs exceed 28% of your gross monthly income, it’s going to be a lot harder to keep your necessary expenses below 50% of your take-home pay.
Make sure you keep that in mind when you’re deciding where to live. You may have to go above 28%, but know that means you’ll have to sacrifice elsewhere in the budget. Avoid putting life expenses on credit.
Crossing The Threshold Straight To Being Broke
This is just a budgeting rule of thumb, not something hard and fast and unbreakable. You can certainly keep below the 28% threshold and free up more of your money.
You can go above the 28% threshold if it’s necessary. Maybe you live in an expensive city, and that’s the only way to make sure you’re in a safe neighborhood.
But be careful.
You want to make sure it’s a conscious choice and you’ve decided where there will be trade-offs in your budget. Otherwise, you risk becoming house poor or going into debt. Frustrated that you never seem to have enough money, and you can’t figure out why. Credit isn't for floating your life costs.
Conclusion
Ultimately, your budget is uniquely yours. It’s a way for you to decide what your priorities are, and to allocate your money to those priorities properly.
Sticking to a budget isn’t a way to restrict yourself to arbitrary rules, it’s a way to reach your goals. Budgets let you live a life that excites you and get out of debt.
There are a few financial rules of thumb you can follow if you don’t know where to begin. But you should weigh every rule of thumb against your own life and finances before you decide to adopt it.