Budgeting 101

Budgeting sounds really simple in practice: track your spending and make sure it’s less than your income. But if it were that easy, the average American wouldn’t have over $16,000 in credit card debt and we’d all have plenty saved for retirement. Budgets have gotten a bad rap as being synonymous with restriction, but if you’ve read my ‘About Me‘ you this is not a blog about extreme frugality or coupon clipping. Money is a limited resource so budgeting just comes down to choices… you can have anything, but not everything. Your budget shouldn’t scare you, it should empower you. Your goal is to be in charge of your money and not vice versa.

The first step is to ensure you have a good grasp on what your true take-home income is. Unfortunately, that salary that you negotiated for (you did negotiate right?!) isn’t what you get to take home with you. After taxes, social security, healthcare premiums, 401(k) contributions, etc. you may be bringing home a lot less bacon than what you expected. This is just another friendly reminder to ensure that your tax withholdings are up to date. If your taxes are under-withheld (i.e. you pay less than you owe) you’ll end up having to write a check that you may not have budgeted for. On the other hand, if you pay more than you owe and get a refund, you may be bummed to find out that you could have afforded that girls weekend you skipped after all.

Once you have a good idea of what you get after taxes and deductions comes the hardest part: doing some detective work on where that money goes. There’s no one way to do, but I think fewer and fewer people are balancing a checkbook as technology advances. Personally, I absolutely love Mint, but I know it’s not the only option out there. I’ve also tried Personal Capital and I’m currently testing out You Need a Budget (YNAB). I’m planning to compare and review them all in the near future so stay tuned. The most important thing is to pick a system and stick to it. The easiest expenses to nail down are those fixed costs that don’t change month to month; for example, you probably already know what you’re paying for rent, that Netflix subscription, and your gym membership. On the other hand, items like groceries, dining out, shopping, and your gas and electric bill may vary seasonally. Ideally, I’d take at least a 3-month look back and in a perfect world, I’d use a year. Why? You want to capture lumpy items such as increased spending for gifts around the holidays or maybe more travel in the spring, etc. to come up with an annual average.

Once you know what your income is and what you’re spending you’ve got a few questions to answer. Are you spending less than you’re making? If not, no sweat, just the fact that you’re starting to organize your finances is a step in the right direction. Your next task is to figure out where you can reprioritize your spending, which leads me to my next question which is much more objective: are you spending your values?

When I meet with clients they often want to know if their spending is “normal.” The problem with that question is that there is no right answer. What is important to one person may not matter for another. For example, travel may be incredibly important to Eliza and she may be willing to pack her lunch and skip a cable subscription in order to take a couple fabulous trips each year. On the other hand, Angelica may prefer to make her clothes last a few extra seasons in order to eat at the best restaurants in town and have that iced caramel macchiato every morning. Neither of those is better or worse than the other they are just different and a reflection of each person’s values. Now if you tell me travel is really important to you, but you haven’t taken a trip in a year and your detective work tells you that you’re spending a good chunk on a morning coffee it’s time to course correct. Or maybe you’ve decided that craft cold brew really is something you can’t give up. That’s totally fine so long as you know that it may be at the expense of that weekend trip to Sonoma. The choice is yours to make, and you’re in charge!

With all that said, I don’t necessarily think spending is a total free for all. If Eliza wakes up at age 65 with a passport full or stamps (hoorah!), but has zero savings and is going to have to work until age 90 and doesn’t have medical or disability insurance I’m not into that. I’m personally a fan of the 50/30/20 approach which dictates that no more than 50% of your after-tax take home pay goes to necessities, 30% goes to flexible or discretionary spending, and 20% goes to savings.

Necessities (50%)

Think your home, utilities, food, transportation and clothing for your job (notice I didn’t say for brunch), insurance, and minimum debt payments, etc. These are the things that you absolutely must pay for. As with everything, there’s wiggle room… you may be willing to rent a studio instead of a one bedroom so you can buy lunch at work rather than bringing it. But I also don’t think you should live here and eat all your meals at Saison. Or maybe you’d rather take Lyft to the office instead of the bus, but that means you’re grocery shopping at Trader Joe’s instead of Whole Foods (but actually I love TJs and think I would shop there even if I had been the Powerball Winner). Of course, this 50% is the maximum amount so by all means you could spend less on necessities and save more.

Discretionary (30%)

This is where the fun stuff comes in! Vacation, shopping, meals out, cough*Warriors games*cough. Now there are some items in this category that I would consider a gray zone or near necessities like a cell phone. You might need one for work, but you certainly don’t need a huge data plan so you can stream constantly (as Roberto likes to remind me whenever we get a friendly alert from Verizon). You’ll also notice I included meals out which I do treat differently than the necessity of groceries or grabbing a sandwich for lunch at work. Everyone may have a different view on how to delineate those wants vs. needs, but it’s up to you to create your own rules and follow them. This is the category where Roberto and I’s “allowance” or “fun money” comes in (if you haven’t read about how we merged our finances see here). The majority of our discretionary spending is on joint items that benefit us both: vacations, date night, entertainment, etc. But we also have an allotment that is ours to save or spend however we please. I have no idea what Roberto spends his on (jk jk I do, it’s totally watches), but mine goes to my gym membership which Roberto doesn’t categorize as a need since he just runs outside, getting my hair done, dinner and drinks with just my girlfriends, etc.

Savings (20%)

Last and most definitely not least is savings. Here’s the dealio: you should be saving for something for your future and in some cases this may mean saving yourself money on interest by paying down debt. I’m going to talk more about savings once we move past budgeting but it could be for anything from an emergency savings, to a down payment, to retirement, etc. This doesn’t mean that when your emergency savings is fully funded you get to spend this 20% either. Start saving for something else. Also, while the 50% and 30% recommendations for the categories above are intended to be the maximum, nobody is stopping you from saving more! So by all means skip the Uber, walk to work, and tackle your student debt if you’re able.

 So a few questions for you:

  • Are you spending your values?
  • Do you feel like you know what you spend?
  • What’s your favorite software/app for tracking your spending?

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