A few weeks ago, I had a conversation with a recent college graduate who was preparing to buy his first car. He had an encyclopedic knowledge of every feature and option offered on each car he was considering and yet seemed unsure of the right choice. I asked what was the cause of his indecision and he said, “I know what I earn but I don’t know what I can spend” (did I mention he is a very smart, young man?).
I gave him the standard 28/36 financial planning rule of thumb; spend no more than 28% of your gross monthly income on total housing expenses and no more than 36% on total debt. Considering the fact that my young friend is hoping to move out of his parent’s home within the year, I told him to make sure he included an estimate for rent and utilities and then factor in a car payment.
While a budget wasn’t first and foremost in his car-buying thought process, he began to understand that the car decision would impact the next item on his wish list, an apartment. This led to a conversation about budgeting, his dislike of spreadsheets and the tedious chore of tracking expenses. He seemed to be a perfect fit for the 50/30/20 plan.
From the book, All Your Worth: The Ultimate Lifetime Money Plan by Elizabeth Warren and Amelia Warren Tyagi, the 50/30/20 plan provides guidelines for spending and saving using after-tax dollars or take-home pay. The goal is to direct your monthly income so that 50% is allocated to needs, 30% to wants and 20% to debt reduction or savings. Easy even for those with an aversion to spreadsheets! The only trick initially is to properly categorize expenses so you can determine where your money is going and where you need to make adjustments. Here are the basic guidelines.
This category includes the necessities of life such as food, housing, utilities, insurance, car payments, gas and minimum credit card repayment.
Here we find cable TV, vacations and travel, sports tickets, unlimited phone plans, hobbies, restaurants, coffee shop visits, gym memberships, expensive haircuts and clothing.
This category includes extra money used to pay down credit card debt, creating an emergency or rainy day fund and saving for retirement.
While you may need something larger than a cocktail napkin to create your own 50/30/20 plan, you don’t need a spreadsheet to track every penny to get off to a good start. Give it a try and see where your money is going and where you may be able to adjust. It may even help you make better decisions like which car to buy.
Nancy Blackman, CFP®