last updated August 3rd, 2021
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Only 32% of Americans have a financial plan they follow. We will focus on created a budget that includes streams of income, current expenses, savings, upcoming and planned expenses. I’ve met clients who made $25,000 a year and were able to have a significant amount of money saved. I’ve also met clients who pay more in taxes than most individuals make in a year and live pay check to pay check.
You cannot build a house until you have a solid foundation and a budget is the foundation to your financial plan. In order to succeed financially, you HAVE to spend less than you earn. The first step is figuring out your sources of income, what is your take home pay. Your take home pay is what you have left over after taxes, what you have deposited into your account.
Section 1: Income.
How much do you make at your day job? Do you have an additional job, a temporary job or a side hustle? Do you sell things on eBay or etsy for extra income? Do you Uber, Lyft or have any other ride share/delivery side jobs? Do you receive child support or alimony (if you do, for how long?) Does your significant other also work? Do you have a roommate who pays you rent? Do you receive a tax refund? Do you have any guaranteed sources of income? Pension, Annuity, Social Security, Disability? We are going to add those numbers up and save it in the income section. So now let’s meet our hypothetical client, Anita. She makes twenty dollars an hour, and works forty hours a week. Her gross weekly pay (her pay before taxes and deductions) would be $800. We take away 25% of her income for taxes and deductions. She is left with a net (her pay after taxes and deductions) amount of $600 per week, but also makes $150 a week after fuel expenses driving for Uber on the weekends. Keep in mind that a lot of ride share companies do not withhold income taxes. Most of her months will be approximately $3,000 of income.
$20 Per Hour X 40 Hours Per Week – 25% deduction = $600 per week
Weekends Ubering after fuel expenses = $150 per week
Monthly = $3000.
Section 2: Expenses.
After we find out how much you take home, now we need to find out how much money goes out every month. How much is your portion of the mortgage or rent? Do you split expenses with anyone? What is your portion of utilities? Vehicle payment, medical insurance, life insurance, cell phone, cable, internet, student loan minimums, personal loans, and credit card minimums are factored in. How much do you average per month on food and fuel? Any additional monthly expenses such as Netflix, Hulu, Apple Music, Gym Memberships, Online Gaming, Fees and Dues?
That number is your “monthly expenses”. We take monthly expenses and subtract guaranteed sources of income. We need that number multiplied by three if you have someone splitting the bills with you, and multiplied by six if you are single. The idea is, to be able to live off of your savings for six months if you leave (or are “politely asked to leave”) work. Two people can live off of 3x monthly expenses in savings if one party is working. How much do you currently have in savings? Can we take what you have, subtract it from what you need and reach that goal in 24 months? If not, we run into one of two issues, we either are living too expensively or have too much debt, or both.
Senator Elizabeth Warren popularized the 50/20/30 budget rule in her book “All Your Worth: The Ultimate Lifetime Money Plan.”
The basic rule is to divide your take home pay, 50% of your take home pay should be used for necessities. Rent, Mortgage, Utilities, Car Payment, Insurance (as highlighted in the worksheet in yellow). If you are over the 50%, it can make things rather difficult. The honest question we can ask ourselves are: can I increase my income (by eg. renting out a room, work more hours per week, start side gig)? One in 20 Americans have two or more jobs. There’s no shame in doing what it takes to pull ourselves ahead.
20% is used for you debt reduction and savings goals. Most often, it can be split half and half. However, more often than not I see a large amount of debt, that even with minimum payments, far exceeds the 20%.
This is where the 30% comes into play. 30% is usually used for luxuries, entertainment, etc. The “don’t go crazy and only spend money on bills” relief fund. If we are overwhelmed by debt, have a large deficit in savings, we need to pull from the 30%. So that means, can we cut back on cable, internet, phone bill, dining out, shopping, Starbucks runs, gas station quick snacks as you fill up your tank? We need to be more conscious of the financial choices we make. $5 a day in overspending is $150 a month, maybe that could have gotten us out of credit debt, saved money etc. The good news is, once you reach your savings goal, you could use the money you were putting into savings for something else.
Now we go back to Anita. She rents an apartment with her best friend in which her portion of the rent is $600. $200 covers her electricity, water, cable and cell phone bill. $250 for her auto loan and $150 for her auto insurance. $25 to her life insurance policy rounds out her monthly expenses to $1,225 which leaves her at 41% of her take home pay being used for fixed expenses, under the 50% ideal threshold.
Anita’s Fixed Monthly Expenses
Rent $600, Utilities $200, $400 Auto Loan and Insurance, $25 Term Life Policy $1225 per month in fixed monthly expenses. 40.8% of her budget Anita has done well with her fixed monthly expenses, and is in debt. She owes $23,000 to her student loans with a minimum payment of $225. She has a personal loan with a remaining balance of $3,000 and a payment of $200 per month. She has a bank credit card with a $2,000balance and $75 minimum payment, a store credit card with a $1,500 balance and $50 minimum payment and a $500 airline credit card with a $50 minimum payment. Her monthly debt minimums total $800 per month.
Student Loan $225, Personal Loan $200, Bank Card $75, Store Card $50, Airline Card $50 $600 per month in debt repayment. 26.7% of her budget. In continuing to review the budget, we look towards the variable expenses Anita has. Anita spends approximately $100 a week on groceries and $50 a week on fuel for her day job. Aside from eating at home, she also dines out a couple times a week which is usually about $50 total. Her subscriptions and memberships are: gym at $25 per month, Apple music $10 per month, Netflix $10 per month, and Amazon Prime $10 per month. Her monthly variable expenses total $855 per month.
Anita’s Variable Expenses
Food and Fuel $800, Memberships and Subscriptions $55. $855 per month in variable expenses. 28.5% of her budget.
Section 3: Emergency Savings.
Anita has no savings. The thought of losing her job had never crossed her mind. When reviewing her income of $3,000 per month and expenses of $2,680 per month, we came across a $320 amount after paying her expenses. I asked her “Does it feel like you have $320 at the end of every month?” Unsurprisingly, she says no. Her money feels like its gone within minutes. This is when I usually ask how often Starbucks, clothing or miscellaneous shopping takes place. Habitual spending can be more costly than debt. I remind her, we have to spend less than we earn. Her emergency savings goal is $16,080 which is six months of her combined expenses. Do I expect her to hit that overnight? No. Is that savings amount going to change? Absolutely. That amount includes her minimum payments for her loans and revolving credit. Once those are removed, the savings require amount will lower. If we obtain a form of guaranteed income, it will also reduce the emergency savings amount.
Anita’s Savings Plan
$25 per weekly paycheck as a start, to build the habit of saving. The key to maintaining a healthy budget is sticking to it and reviewing it as often as possible. Simply “hoping for the best” is not a prudent strategy.
- Document your budget.
- Track it frequently
- Review it often, especially when debts are paid and savings goals are met
- Speak with a financial planner whenever possible
I have created nearly 10,000 financial plans in my career and almost all of them started with correcting a budget. I often find myself being a budget planner and that’s okay. It’s never too late to get back on track.