When it comes to how to do a budget, one size doesn't fit all.
Photo: StockMonkeys.com via Flickr.
If you spend some time reading about how to do a budget, you'll likely run across some recommended ratios for how you might allocate your money. These ratios can help in your thinking, but think twice before following them precisely -- one size doesn't fit all.
The 60/10/10/10/10 budget
Zenhabits.com recommends a 60/10/10/10/10 budget.This formula involves spending 60% of your gross income on your regular monthly expenses (rent or mortgage payment, food, utilities, transportation, and even Internet access), 10% on retirement savings, 10% on long-term savings or debt reduction, 10% on short-term savings (for expenses such as gifts and car repairs), and 10% on fun (dinners out, movies, golf, travel, etc.).
The author makes many great suggestions, such as simplifying your financial life by having just a few financial accounts (checking, savings, credit card, etc.) and paying with cash instead of credit cards because paying with plastic often leads us to spend more than we planned or can afford. It is also smart to make a spending category for "fun," which is something that often breaks budgets simply because it wasn't budgeted for.
My beef with this formula for how to do a budget is that it recommends only 10% for retirement savings. That's a common mantra of financial advisors, but the majority of Americans are way behind in their savings and should really sock away more than that. According to the 2014 Retirement Confidence Survey, for example, 60% of American workers have less than $25,000 saved for retirement (excluding the value of their home), and 36% of American workers have less than $1,000 saved for retirement. If you're only a decade or two from retirement and don't have much more than Social Security to count on for retirement income, putting aside 10% of your income may not build a big enough nest egg for you.
Meanwhile, if you have high-interest-rate debt -- for example, from overly enthusiastic credit card use -- you should put much more than 10% toward paying that off if possible. It makes sense to wipe out as much costly debt as possible before putting money toward retirement, too.
The 50/20/30 budget
One formula for how to do a budget that seems more doable for many is the one popularized by Massachusetts Senator Elizabeth Warren and her daughter Amelia Warren Tyagi in their book All Your Worth: The Ultimate Lifetime Money Plan. It recommends allocating roughly 50% of your take-home pay to your needs (such as rent or mortgage payments, food, clothing, insurance, transportation, utilities, etc.), 20% to your savings (this includes debt repayment, retirement, and an emergency fund), and 30% for "wants" such as entertainment, recreation, travel, and even such expenses as haircuts and charity.
This approach does present some challenges, such as its broad categories. It can sometimes be easier to deal with more and narrower categories, as you can then see more easily where your money is going. Some might also take issue with the notion that haircuts and cellphones are considered "wants." But to a great degree, these are discretionary expenses, especially given that we can choose a $15 haircut over a $200 styling and a basic phone over a high-tech smartphone. The Warren plan also deems pet food a want, which might rub some the wrong way, as might her similar categorization of tithing. We all have somewhat different ideas of what we need, and no formulaic plan can decide that for us.
Create your own ratio
Perhaps the greatest value in formulas like the ones above is that they can help you structure the allocation plan that works best for you by giving you some templates to start with and adjust as needed. It matters little whether your charitable giving or pet food is categorized as a "want" or a "need," so long as you account for them when you create your personal budget.
Thinking about how to do a budget means listing all the categories you spend money on and looking at how much income you have and how you can best distribute it. Make sure your budget includes debt repayment and savings for an emergency fund and retirement: Whether or not you're addressing these expenses now, you need to, and a budget can help you do it.
Longtime Fool specialist Selena Maranjian, whom you can follow on Twitter,has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
