Updated: 10/27/2011 1:53 PM ET|
Simpler saving: The 60% Solution
Years of complex budget calculations have led me to a simple conclusion: If you limit essential spending to 60% of total income, your savings will soar.
How many of you have tried budgeting and think it's a waste of time? Come on, let's see those hands.
OK, that's just about everybody.
I've kept a budget of one kind or another, first on paper and then with the help of various software programs, for many years -- despite a strong suspicion that I was wasting my time. The illusion of control, I argued to myself, was better than none at all.
My approach to budgeting was to carefully track my spending during the month and to adjust my budget targets up and down in each category, so that my total expenses never exceeded my income.
Useful? Sometimes. Anal-retentive? Probably.
After two decades of this, though, I started to wonder if there isn't an easier, more effective way to budget. I realized that the hardest part about keeping a budget is getting useful information from it. There's too much detail and not enough bottom line. My answer is the 60% Solution, a faster and easier way to structure your budget without having to account for every penny.
What you're trying to do with a budget is to prevent overspending, which ultimately leads to piling up debt. Contrary to the way most people budget, however, it rarely matters what you're overspending on -- dining out, entertainment, clothes. Who cares? It's still debt, right?
Looking at my own spending history, I realized that it wasn't the little luxuries here and there that got me in trouble. It was the large, irregular expenses -- like vacations, major repairs and the holidays -- that did all the damage. To avoid overspending, I had to do a better job of planning for those.
And then there were the really big expenses: buying a car, putting a down payment on a new home or putting a new roof on an old home, all of which can run into the tens of thousands of dollars. They also can often be postponed, sometimes for years, which theoretically should give me a chance to save for them.
Understand your committed expenses
As I looked back over the past 20 years of budgeting, I saw that there were a few years when my wife and I believed we were fairly on top of things, even with a much lower income. How did we manage?
The key was a drop in our fixed monthly expenses. It was a period when declining interest rates had lowered our adjustable-rate-mortgage payment to about 15% of our household income. That left us with some extra money each month to set aside in a savings account for those irregular expenses.
We later moved to a bigger house with a much bigger mortgage payment, higher maintenance costs and utility bills, and obscene property taxes. The monthly mortgage payment was only 20% of our gross income, far lower than the 33% that most lenders will allow, but, suddenly, we were struggling again.
Even after refinancing our mortgage at a lower rate, we were still often running out of cash before the end of the month. I realized that other fixed expenses had crept upward over the years. As my children, Natalie and Jackson, got older, they needed things like music lessons and sports equipment that added several hundred dollars a month to our basic expenses. They were also outgrowing clothes faster than we could buy them.
The slow but steady growth in our monthly spending commitments was putting a squeeze on our budget. I call these "committed" expenses rather than "fixed" or "nondiscretionary" expenses, because things like music lessons are neither fixed in amount nor absolute necessities, but rather are commitments my wife and I made to provide for our children.
The 60% Solution emerges
After analyzing our spending patterns over a couple of years, I determined that we needed to keep our committed expenses at or below 60% of our gross income to come out ahead at the end of the month.
- Basic food and clothing needs.
- Essential household expenses.
- Insurance premiums.
- Charitable contributions.
- All of our bills -- even such nonessentials as our satellite TV service.
- All of our taxes.
I'm not saying that 60% is a magic number. It's been a workable goal for my family, and it's a nice round number. Your number might well be a bit higher or lower. At any rate, it's a good place to start.
Then I divided up the remaining 40% into four chunks of 10% each, listed here in order of priority:
Retirement savings. This consisted entirely of my payroll-deducted 401k contribution.
Long-term savings. Before I retired, this was also automatically deducted from my pay. I purchased Microsoft stock at a discount as part of an unusual stock-purchase program. The relative lack of liquidity (that is, the difficulty of turning these shares into cash) made it harder to spend this money without some planning and a series of deliberate steps.
Short-term savings for irregular expenses. These were direct-deposited from my paycheck into a credit union savings account. Money in this account was easily transferred into our checking account, as needed, via the Web. This was the money I relied on to pay for vacations, repairs, new appliances, holiday gifts and other irregular but more-or-less predictable expenses.
Fun money. We could spend this on anything we liked during the month, so long as the total didn't exceed 10% of my income.
You may have noticed that only 70% of my paycheck was used for everyday expenses. Because we never saw the remaining 30%, my wife and I didn't miss it.
We didn't really need to track our expenses, because our checking account balance was generally equal to the amount of money we could spend. That's the way a lot of people do it, but they don't first make provision for savings.
The key is keeping a lid on those committed expenses. You can categorize them if you want, but it isn't really necessary. In fact, you could make a budget with just three categories: committed expenses, fun money and irregular expenses.
Now, at this point you may be saying, "Well, la-dee-dah for you, but there's no way I can get my committed expenses down to 60% of my income."
Getting to 60%
For a lot of people, part of the difficulty in reducing committed expenses comes from the need to make big monthly credit card payments.
If you're carrying a substantial amount of non-mortgage debt, I'd suggest using the 20% that otherwise would go to retirement and long-term saving to aggressively pay down your debt -- but only after you cut up those cards.
Every dollar in interest that you don't pay is just like getting a guaranteed, risk-free, tax-free return on your money equal to the interest rate on the debt. When your debts are paid off -- and it won't take long using 20% of your gross income -- immediately redirect that money into savings.
Now, let's take the really hard case: Even excluding debt payments, reducing your committed expenses to 60% still seems like an impossible goal. If that describes your situation, the odds are good that you're facing one of the following problems:
- You have a more expensive home than you can afford.
- You've committed to car or boat payments that are larger than you can afford.
- Your children are in a private school that you can't really afford.
- There's just a big, ugly gap between your income and your lifestyle.
If it's one of the first three, you can undo the damage by slowly unwinding the commitments you've made and choosing something less appealing but ultimately more appropriate.
If the problem is having champagne tastes on a beer budget, you'll need to take a long, hard look at where the money is going and why. Perhaps you're using money and things to fill a void in your life. Often, the steps needed to fill that void have little to do with money.
The real secret to building a budget that works isn't tracking what you spend, any more than counting calories is the secret to losing weight. The key is creating a sustainable structure for your finances, one that balances spending and income and that leaves enough room to handle the unexpected.
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You say you calculated 60% of the GROSS income.
Then you took the rest and divided it into 4 parts of 10% each.
What about the taxes that you pay on your income?
Let's say you earned $1,000/ week. 60% is $600. Aren't you paying about $300. in taxes? In your calculation, you still have $400 to divide between the 4 categories. What am I missing?
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