For many years people have been trying to budget and save for some of the most important events in their life. From legacy planning to retirement, the big questions has always been; do I have enough money? So how does one answer this question? Often times, we see that people are waiting for that big payday like a promotion, bonus check or even winning the lottery. The reality is what happens when that job is eliminated or bonuses have been removed. Hanging your hat on winning the lottery is a long shot as only one in 175 million people actually win. So what’s the proper or more efficient way of saving for life’s big events?
Budgeting is essential to your financial health and overall financial plans. Many advisors and financial gurus have provided many ways of budgeting. Over the years there have been infomercials, seminars, books and internet sites that suggest various budgeting methods. From maxing out contributions to qualified retirement plans to putting money away in savings accounts. While these may be great budgeting or planning techniques let’s get back to the foundation. If the foundation is cracked then the building can’t stand.
Think of the carpentry industry. When someone wants to build a home, there are several steps in the process that must be completed before the house can be constructed. First an architect is hired to design the home. This gives the rest of the construction team a vision to work towards. If there’s no vision, then there’s no path to get there. So when it comes to your finances, you have to create a vision for your money. Answering questions like; what do I want my life to look like while I’m in retirement? Or what do I want my financial legacy to be? Among others, these are important questions to consider as you create a vision for your financial life. Let’s continue…
After the Architect designs the home, next, there’s a construction team that comes in and get started on the structure. They are responsible for the next step in the process. They have to build the foundation and it must be exactly as the architect has designed. Now once the foundation is laid, there can be some changes as to the overall visual design of the home. Same with your finances. Once you have created the vision for your life, now you can start working towards that vision. Building the right foundation is essential to achieving this goal. Understanding your spending and saving habits will assist in this stage of foundation building. Therefore, what’s the proper way to sufficiently construct our lives from a financial point of view?
Rule of 50/30/20
Some quote this rule as 50/20/30, but this is how I quote it. Keep in mind, this isn’t the only budget method available, however it has proven to be a solid beginning in building a stable financial life. The rule simply says that we should spend 50% of our income on essentials, 30 % on discretionary and 20% on savings goals. Essentials are things like mortgage/rent, monthly utilities, groceries and perhaps transportation to and from work. Discretionary are things like vacations, that new car, jewelry, expensive dinners etc. Savings are money market accounts, emergency funds, investments etc. Keep in mind the percentages for the Discretionary bucket are the highest percentage, meaning that’s the ceiling for that category. For example:
If Person A brings in $5000 per month, then the rule would state that $2500 should go towards his/her essentials, $1,500 towards discretionary spending and $1,000 towards savings goals.
If this rule is followed we can see from the example above that Person A would be able to save $12,000 per year forwards his/her savings goals. Sounds good right. But does this model work for everyone? Well that depends on what the 30% category is spent on. Many times we can recalibrate our spending by altering the 30% category. Perhaps Person A doesn’t need to spend $1500 per month on hanging out or doing other desired things. Perhaps he/she can place an additional $750 towards helping him/her reach his/her savings goals.
All in all, having a budget will help to ensure that you are properly positioned for financial success. While this is a high level overview of this budgetary idea, it certainly is a foundation for people to have financial successes during their lifetime.
Terrell Wilson, CRD