What is the optimal budget? That is tough to answer, as everyone’s optimal budget will be unique to them.
I don’t believe in using rules of thumb. Everyone has different dreams, goals, and has external factors that need to be considered when crafting a budget. However, I’m happy to lay a foundational blueprint of an optimal budget that I use with many of my clients. This needs to be adjusted for each unique individual or family but it is a great starting point.
Why You Need a Budget
Positive cash flow and discipline are paramount to building a strong financial foundation. Without them, nothing else will ever be consistent. Americans struggle mightily with managing cash flow. A few statistics:
- A Gallup poll shows that only one in three Americans prepare a detailed household budget.
- 62% of Americans have less than $1,000 in savings, meaning most families are living paycheck to paycheck.
- Financial worries are up. Among them, “having the ability to pay my normal monthly bills.”
Families are worried. They are spending too much, saving too little, and it affects them emotionally just as much as it does financially. In order to start living below your means, which in turn will give you more flexibility with your money, set up a budget and stick to it.
What is the Optimal Budget?
When helping clients design their optimal budget, I break down their spending into 9 categories. Please note that these allocations are based on net income. Here are the 9 categories, a starting allocation, and a summary of each:
- Housing (30%)
- Mortgage/Rent Payments
- Transportation (15%)
- Auto Loan/Lease
- Car Insurance
- Food (13%)
- Dining Out
- Savings (10%)
- Traditional/Roth IRAs
- Cash Reserves
- Brokerage Accounts
- Vacation Fund/Down Payment Savings
- Life/Disability Insurance Premiums
- Debt Payments (10%)
- Auto Loans
- Credit Cards
- Student Loans
- Personal (7%)
- Personal Development
- Gifts / Clothing
- Entertainment (5%)
- Other Leisure
- Out-of-Pocket Health Expenses
- Gym Memberships
- Church Tithe
- Charitable Giving
Fine-Tuning Your Budget
Again, these percentages are a starting point. Many external factors come into play. For instance, for those living in large metropolitan areas, the housing may be much harder to keep at 30% or under. On the flip side, they may not need a car to get around, so it could be a wash. It’s important to factor in these items. If you have children, you may need to include 529 accounts into your savings, account for higher grocery and health costs, and factor in child care. Your budget should be exactly that, yours.
I’ll reiterate that these are based on after-tax income. Most of my clients have health insurance through their employer. If you don’t, this will put a big dent in your budget. Also, my 10% savings assumption is that you are also investing through salary deferrals in your work retirement plan. If that is not an option, I would do your best to increase that percentage to over 10%.
Fixed Expenses are Key
Want to give yourself financial flexibility? Manage your fixed expenses. Contrary to what some say, you aren’t going to become financially independent by eliminating morning coffee runs or buying off brand mac & cheese. If you really want to make a difference, lower fixed expenses. If you were pre-approved for a $300,000 mortgage, that doesn’t mean you should spend that much. Buying a used car rather than a new one is another example. If you can find a way to spend a few hundred dollars a month less, and invest the difference, you’ll be doing yourself a huge favor.
How to Stick to Your Optimal Budget
The first thing to do is utilize technology. There are many great tools out there to help you track and stick to a budget. My favorite is YNAB, or You Need a Budget. You can use the tool either online or through a mobile app. YNAB believes in giving every dollar a job. You can use the above categories as a guide. It’s simple and easy to attach your banking info and start tracking your budget. You can do it all in under 10 minutes a month. (FYI: YNAB is $5/month. Well worth it.)
The next way to stick to it is to automate as much as possible. Automating savings and bill payments will free up time and reduce the chances for errors. Online banking through Capital One 360 or Ally allows you to create multiple accounts for different goals hassle-free. Not to mention the interest rates are favorable compared to your local brick & mortar banks.
Conclusion: What is the Optimal Budget?
It’s easy to let your spending get out of control. Set up a budget, asap.
No budget will work unless you commit to it and track your progress. Use this article as a guide to crafting the best budget for you. Do whatever you can to keep your fixed expenses well below your means. This will give you flexibility moving forward. In just a few minutes a month, you can remove the guesswork from your cash flow.