Budgeting is hardly the most exotic or exciting aspect of financial planning, but it is one of the most important. Whether you think it’s boring or not, budgeting is one of the key foundations on which we build a sound financial plan.
So many new clients I meet have no clear idea of how much they spend now or plan to spend in the future. Until they see the numbers in black and white, they don’t have a clear perspective on where their money is going and where they could put it to better use.
If you want to get a handle on what you’re spending, here are three interesting approaches that might work for you.
1. The 50/30/20 budget
US Senator and Harvard bankruptcy expert Elizabeth Warren coined the 50/30/20 spending rule in a 2005 book, All Your Worth: The Ultimate Lifetime Money Plan.
There are four steps to organising your budget.
- Calculate your after-tax income. For employees, that’s your net pay plus any deductions taken out for pension, etc. For self-employed workers, that’s your gross income minus expenses, plus the amount you set aside for tax.
- Limit your ‘needs’ to 50% of this income. Work out how much you spend on ‘needs’ each month – such as food, housing, utilities, insurance, car payments, and car insurance (any payment that would severely impact your quality of life, such as electricity and prescriptions, is a ‘need’). The amount that you spend on these things should total no more than 50% of your after-tax pay.
- Limit your ‘wants’ to 30% of this income. This isn’t just holidays and meals out; this is your streaming TV subscription, your mobile phone, and your non-necessary clothes.
- Spend 20% of your income on savings and debt repayments. This is the money you pay to your credit card each month, your pension contributions, and any savings. Your mortgage payment is a ‘need’, but any additional payments you make form part of this 20% category.
While financial planning can help with this 20%, it can also help elsewhere. For example, a remortgage to a better interest rate might free up more of your income to save, repay debts, or increase your pension contribution.
2. The ‘five-category’ budget
The ‘five-category’ budget allows you to break down your spending into basic categories, so you can see where your money is being spent and adjust, as necessary.
If you follow this budget, you’ll automatically put aside a portion of your money to pay debts and save, both of which can help you to reach your financial goals much sooner.
Ideally, your housing should take up no more than 35% of your take-home income. This category includes:
- Your mortgage and rent
- Repairs and maintenance
- Council Tax
- Utilities such as electricity, gas, and water
- Home insurance.
Getting about should take up no more than 15% of your take-home income. If you drive, this figure needs to include not just the payments on your car, but fuel, repairs, insurance and even a regular car wash.
This 15% should also include the cost of parking as well as any public transport you use, from the bus to work to a train to visit family.
Other living expenses
Other living expenses should take up no more than 25% of your take-home income.
This typically includes discretionary spending such as eating out, concert or theatre tickets, new clothes, tickets to sporting events, and taking the family on holiday.
Your mobile phone bill, TV subscription and broadband also fall into this category, unless they are essential for work.
I’ve said before that paying yourself first (i.e. putting money aside for savings on payday, not at the end of the month when you may have little left) is a good way to live.
Each month, budget to save 10% of your pay. These savings could be an emergency fund, your pension, or to fund a new house purchase or your child’s education.
Paying debts should take up no more than 15% of your take-home income.
While this doesn’t include your mortgage or car payment, it will include personal loans, credit cards, and student loans.
This ‘five-category’ approach is slightly more ambitious than the 50/30/20 model as it means you’re spending a combined quarter of your take-home income on savings and debt repayment.
3. The spreadsheet budget
If you want a more DIY approach to budgeting, creating a spreadsheet of your income and expenditure can help you to keep control of your money.
Firstly, gather a couple of months’ worth of bills, bank statements, payslips, receipts, and any other record of expenses.
Use a budget template from Google Sheets or an Excel spreadsheet and then list:
- All your income – from employment, self-employment, investments, interest, dividends, and freelance work
- All your expenses, including direct debits for your mortgage, rent and utilities as well as spending on food, loan payments, debt repayments, and discretionary purchases.
Take away the total of your expenses from the income total to get a general picture of your financial health. If your total income is higher than your total expenditure, here is the money you have for saving, investing, and repaying debt.
If your total expenditure is higher than your income, you’ll need to identify where you can make some savings if you want to balance your budget.
You can take a further step with this approach and categorise your expenses into fixed, variable, and discretionary expenditure:
- Fixed – your rent or mortgage payments
- Variable – utility bills, insurance
- Discretionary – these are ‘wants’ rather than ‘needs’ and are likely to be where you make the most savings.
Get in touch
Budgeting is a cornerstone of the financial planning process. If you want to get a better handle on your income and expenditure, and you’d like to get more financially organised, please give me a call on 07769 156 250.
Foster Denovo Limited is authorised and regulated by the Financial Conduct Authority.
You may have to pay an early repayment charge to your existing lender if you re-mortgage.