The "B" Word

In personal finance, it all starts with cash flow. What comes in versus what goes out. How healthy is your personal cash flow? There are usually two camps- those who are always tight at the end of the month and can't figure out where the money goes, and those who have a surplus but don't necessarily know the best place to hold it.

Let's focus today on the first group, because that is the one with which I identify best. And by identify, I mean exemplify, because I am a spender. So we are going to use the dirty "B" word- budget.

 Wait! Don't leave yet. I know you hate budgets. I hate budgets. In financial planning 101, we begin by marking down every expense you have and breaking them down into 100 specific categories. Who has time for that? And what happens when I go over-budget in one category but under in another? And why do I feel so damn guilty every time I write down the amount of the concert tickets line item? (Mom, don't answer that).

Which is why I LOVE the 50/30/20 budget from ELizabeth Warren's fantastic book "All Your Worth", co-authored by her daughter Amelia Warren Tyagi. The premise is simple- structure your budget so that 50% of after-tax pay goes to "must-have" expenses, 30% to "wants", and 20% to "savings". So far, so good.

Your "must-have" expenses are those that must be paid every month regardless of your situation. Housing, utilities, debt repayment minimums, and basic food costs are all considered "must-haves". 50% was not chosen merely because it is a nice, round number. "Must-have" expenses are kept at 50% because if you were to lose your job and collect unemployment, or go from two incomes to one, or collect disability insurance, you would likely receive approximately half of your current take-home income. This means that in tough times, you could shed your "wants", pause your "savings", and still survive without tapping into savings or going into debt. Click here to download a basic "must-haves" calculator from It's Your Money and see where you stand. Even if your expenses are within 50%, experts agree monthly debt obligations (including mortgage payments) should remain within 36% of your gross monthly income. 


 The "savings" category of 20% includes contributions to your emergency fund, retirement accounts, and debt repayment over and above the minimums. Debt repayments are included because the more debt you pay off, the more wiggle room you have in case of emergency. Note that these are long-term savings, not future "wants" savings.

 Finally, my favorite- the "wants" category. Shoes, shows, or sushi, you are free to spend 30% on anything your heart desires. Big wants require saving up your monthly wants allowance until you can afford it. Elizabeth and Amelia understand that in order to enjoy life, you have to have the freedom to spend a little discretionary cash here and there. In fact, they suggest using cash for your "wants" so that you don't overspend. Personally I would rather track my purchases and get some credit card points, but if you are prone to overspending it may be a good idea to leave your cards at home and only take out as much cash as you have to spend.

Some expenses fall in two categories. The most common is food. We all have to eat, but does it HAVE to be wild-caught salmon with truffle mashed potatoes and organic asparagus? While some of you will agree with me that it does, the truth is that a single American can survive on $200 a month. This is more than food stamps provides. So put $200 in the "must-have" category and the remainder in "wants". Another one is  basic household needs. Yes, you need shampoo, but it does not have to be Aveda. I find that the majority of my "wants" category is food and music. Yours may be clothes, movies, or cars. Yes, cars. If you want a car that is beyond your budget, you can save your "wants" money until you have a large enough down payment that car loan payments are safely within your "must-have" budget (although even better is saving enough to pay for the car outright).

While I enjoy the simplicity of three categories, I strongly encourage you to reduce your "wants" category to 25% and add a 5% "Giving" category. While most of people unconsciously do so throughout the year, I find that adding donations and gifts as its own category benefits my charitable strategy and allows me to plan ahead which non-profits I will support. 10% giving is my goal, but I am not there yet.

The best online tool I have found for monitoring your budget is mint.com. It is free, easy to use, and they email alerts when you are over your budget in a certain category. You can even track your savings and debt repayment goals.

Let me know how your budgeting goes, or if you have additional tips that work for you.