How Much Should I Save? How to Create the Ideal Budget – and Stick With It

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No matter your financial situation, chances are you’ve worried about how you’re spending your money. Am I spending too much?  Should I save more for retirement, a house, my kids’ education, the sports car I will inevitably purchase during my midlife crisis? Financial management breaks down into two components: Making a good budget, and sticking to it. We’ll help you do both.

Evaluating your financial situation

First step: Figure out how much work you’ll need to do.

  • Are you in debt, and if so, is it good debt or bad debt?Your first priority will be getting debt-free; saving can wait.
    • Good debt is an investment – you’ll get back the interest you pay and then some. Examples can be student loans, an auto loan that provides transit to work, or in some cases, a mortgage. If you spend now so you’ll be better off in the future, you’re taking a healthy attitude towards debt.
    • Bad debt doesn’t raise your earning potential in the long run. You’re financing today’s happiness at the expense of tomorrow’s security. If you’re overspending with no real benefit, you need to be aggressive about cutting costs.
  • Are there any major expenditures you’ll be making in the next 2-3 years? Be sure to budget for these expenditures and have enough saved up when it comes time for the deed to be signed/baby to be delivered/ring to be put on it.

All right, basics worked out. Now to the mechanics: how should you actually allocate your money?

How much should you save?

Generally, the rule of thumb is to save 10% of your paycheck, which is fine if you plan on working until you’re 80 or pursuing an encore career in BASE jumping. I recommend saving at least 20% of your income, and allocating it in this order:

  • Establish a rainy day fund that will see you through 3-6 months.Remember to factor in family support, unemployment insurance, etc. into your rainy day calculations – if you’re 22, say, and don’t mind moving back in with your parents if you lose your job, your rainy day fund can be smaller than someone who absolutely must make her mortgage payments.
  • Pay off your high-interest debts. The best investment you can make is reducing your liabilities. Think of it this way: you can perhaps get an 8% return in the stock market, though it’s risky; paying off your credit card debt, on the other hand, is a guaranteed return of around 12%.
  • Max out your company’s 401(k), if they offer it
  • Max out your IRA contribution
  • Consider a 529 savings account if you or a relative will incur educational expenses in the future
  • Invest the rest in regularly taxed accounts

Given the lessons of 2008 and the projections for Social Security and Medicare, we can’t count on the same level of government support when we retire. Moreover, as we live longer, we require more money to fund our golden years. A 10% savings rate may have worked back in the old days, but now, 20% is the way to go.

How much should you spend?

Now that you’ve figured out how much to save, what should you do with the rest of your paycheck? Though your own calculations may vary depending on your debt levels and tax liability, here’s a good starting point for allocating your post-tax paycheck:

  • 25% to rent or mortgage payments
  • 25% to non-housing necessities like basic food, insurance and health
  • 25% to discretionary spending
  • 20% to savings
    • Note: if you’re currently paying off debts, add 10% from your discretionary spending to this category, and use the money on debt and savings together.
  • 5% to charity (more if you can spare it)

If your debts exceed 30% of your post-tax income, or you simply want to lower the interest you pay on debts, check out our guide on getting out of debt.

Building the budget: Don’t spend money to save money

Now that you’ve sketched out a rough idea of where your spending should go, it’s time to go line-by-line and fill in the details. Most of the grunt work comes in filling in the discretionary and non-housing necessities columns.

For necessities, include:

  • Basic foods, excluding restaurant food
  • Transportation
  • Insurance
  • Medical visits
  • Basic clothing
  • Any other must-pay-for’s

If your absolute necessities dip into your discretionary spending, that’s not the end of the world – just understand why this is the case and act accordingly. We’ll cover ways to cut down on these costs in the next section, but sometimes you’ll need to chip away at the discretionary savings section in order to pay for the basics.

If your necessities budget is under 25% of your income, you have some flexibility (as long as you’re relatively confident you’ll have a steady income stream). You can try to pay off debt earlier, save more, give to the less fortunate or just have fun.

Now it’s time to start writing it down. I can’t emphasize enough how much you don’t need to pay for someone to tell you how to budget. Dave Ramsey sells budgeting software for $17.95, while Quicken’s basic product retails for $39.99. Start your budget off on the right foot by not wasting money on these products when there are myriad free resources available. Mint is the 800-pound gorilla in the free budgeting world; Manilla is another great resource, linking all your spending accounts to ensure that you’re staying on track with your budget. They also provide a great service to help you stay on top of your bills.

And there’s always the simple spreadsheet. Microsoft has a ton of Excel templates, and a Google search will reveal even more. But since Excel is expensive (and we’re cutting costs, right?), consider using free office software like LibreOffice – they also provide budget templates. It doesn’t matter what you use, as long as it’s written down somewhere, you’re diligent about updating it, and you can track your progress.

Sticking to your budget

Okay, so you’ve got your budget all set up, your expenses and income streams totted up in the right columns, and you’re ready to go. It’s time to start living up to the budget you’ve just written.

Set yourself up for success. Financial management is a marathon, not a sprint; a short burst of soul-crushing austerity might yield initial savings, but you’ll want something that you can stick to for years to come. Make sure that your budget isn’t too aggressive, that you automate as much as possible, and you leave room for fun.

Don’t be too aggressive. You’ve added up your monthly expenses; now it’s time to allocate the rest. If your housing or necessities expenditures account for less than 25% each of your budget, allocate half the extra amount to savings and half to discretionary spending. Moreover, if you come in under budget in the necessities category, use the extra money to reward yourself for doing well. Pace yourself and don’t go on an unsustainable cost-cutting frenzy.

Automate as much as possible. Enroll in automatic deductions for your company’s 401(k), if offered, and set up an automatic transfer from your checking account to your IRA or another investment account. Use automatic bill payments for your credit card, utilities and whatever else you can from your checking account, preferably the day after your paycheck is deposited into the account. That way, you’ve already knocked off the basics and aren’t tempted to spend what you never see.

Leave room for fun (and not so fun). It’s important to have a rainy day fund for emergencies, but unexpected, fun expenses can also crop up. A summer full of weddings, an anniversary dinner, a gift for a special friend – these can all take an unexpected chunk out of your budget, so be sure to leave breathing room in the discretionary category.

Social is caring

The next step to sticking to your budget is to involve others. Science has shown peer pressure to be incredibly effective in everything from reducing obesity to quitting an addiction to working harder. Leveraging this social impact is a two-step process: Evaluating the ways your circle impacts your finances, and figuring out how to leverage it going forward.

Build the right community. Your default behavior is often what you perceive others to be doing; if your social circle has trouble living within their means, you will struggle to break the mold. If this is the case, consider finding other forms of social support: Join a communal savings group, or start one among your spendthrift friends. Find a role model, whether or not you know her personally, and make an effort to emulate her actions. Remind yourself that people all around you – whether it’s Oprah, your mom or your neighbor – are practicing good financial management, and you can too.

It’s important that a communal group touches base often, either in person or virtually, to foster a sense of connection and promote good habits.

Leverage your community. Now that you’ve built up a support network of people who will encourage the behavior you want encouraged, it’s time to involve them in the process. Here are a few ideas to get started:

A simple email list. Choose a list of 4-5 people that you trust completely and are not involved in your day-to-day finances (so not your spouse) to be your check-in council. Tell them that you’ll send them an email every Sunday night that you stay under budget, and ask that if you don’t email them, that they contact you and ask why. If you get through a year under budget, do something nice for your council – can’t go wrong with cookies.

A savings group. Join an informal savings group that meets every week or so to simultaneously transfer money from a checking to investment account, write a check and use mobile deposit to put it in the bank, or otherwise have a shared, communal feeling of contribution. If you’re with people you absolutely trust, you can borrow the susu method popular in many African and West Indian countries: each person contributes the same amount, and every week, a different person collects the entire pool. It’s a great way to enforce discipline on your savings, because the money you spend comes out of someone else’s pocket. The downside is that there’s no legal recourse if someone decides to screw you over.

Social sharing websites. Sites like StickK allow you to set goals, designate a referee and even put money on the line. These apps make it easy to share your progress with your social circle and get some skin in the game.

Outsmart yourself

When it comes to impulse control, you are your own worst enemy. Your strategic self tells you to contribute to your 401(k), to work out tomorrow, to eat more veggies. Your impulsive self whispers, life is short so buy the shoes, sleeping totally burns calories, and you can’t tell me what to do, strategic self, I’m going to eat the Cheetos I found in the couch cushions and you can’t stop me!

The way to succeed is to take as much power away from your impulsive self as possible. Automatic deductions to your retirement and savings accounts are one way to do this; Christmas, vacation or wedding savings accounts are another. Beyond that, you need to know where you’re most likely to overspend:

If you spend too much… Then you should…
At the grocery store Use Amazon Subscribe and Save or a similar service to automate as many purchases as possible and cut down on trips to the supermarket.
At restaurants, bars or malls Pay only with cash, and only bring as much money as you plan to spend on that excursion alone. If you’d rather not pay with cash, get a no-fee prepaid debit card, and load it from your bank account to avoid fees.
Impulse-buying online Load your cart with all the goodies you like, then wait at least 48 hours before actually buying.Try linking your online account to a no-fee prepaid debit card, and load the card from your bank with your monthly online shopping budget.If you really have trouble controlling the shopping impulse, install a script that will delay the loading of your designated sites by 5 minutes. This will give you cooling-off time and break the instant gratification connection.
In any one category Use a no-fee prepaid debit card dedicated solely to that spending category.

In the end, it’s up to your strategic self to stop your impulsive self from making short-sighted decisions. This can mean making as many decisions as possible when you’re cool-headed, and enlisting your community to provide support and feedback. You have the capacity to make your financial goals; just don’t let yourself stand in the way.

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