Income Allocation
This section will use net income, since that is the portion of income we can control. This is the money pie that is sliced into pieces and spent. How much is too much for a particular category? Good question. Nothing is set in stone here aside from spending more than 100% of the money pie. That is how families become strangled by credit card debt and payday loans. Not healthy.
Works that study millionaires try to deduce how they ended up with said financial status. My problem with these works is that causation and correlation are not the same. This group is typically older with less than 2% of millionaires achieving such a status under age 30. The majority of those with a net worth greater than $1,000,000 are good savers and investors. Additionally, they keep spending in check. But not everything that found success in a given decade for a given age group sees the same success in other decades. One thing we can all take away is living significantly below our means and putting money away each and every month. So, where to start?
One similarity among millionaires and studies that examined them is that millionaires tend to put away at least 20 to 25% of their income. I say investing a minimum of 25% is the way to go here. 50% is better and what I recommend, but if you are just looking at numbers, 25-50% is a solid range.
This should be the first thing filled every month. Your situation will determine where this 25%, or more, goes. If you have a 401(K) match, take it. Next, prioritize paying down high interest debt such as credit cards followed by student loans. if you are at the investing phase of your life, send this to a 401(k) or personal brokerage to pay you in the future. If being completely debt free is your thing, paying off the house is never a bad way to go.
In equally sized spending piece of the pie is housing. In recent years, housing costs have skyrocketed. I still sit firmly on the rule that one should spend no more than 25% of their net income on housing. This includes the mortgage payment, property taxes, property insurance, and private mortgage insurance (PMI) if applicable.
Vehicles and transportation are usually the next big category at 10%. Cars are depreciating assets, which in my mind makes them a major liability if you overspend on them. This is the net worth killer of the middle class. If you have debt other than a mortgage, I strongly recommend this spending disappears. Much more on this to come.
Utilities, internet services, and cell phones are tough to bypass. Keep this to 10% as well. This category includes electric, gas, water, sewer, garbage, internet, cable, and any cell phone related expenses.
Insurance and taxes usually fall around the 10% mark as well. This varies greatly from person to person. The insurance aspect of this varies greatly. Think health, disability, vision, dental, term life, etc… Pretty much a catch-all section for taxes, aside from property taxes.
Food is essential and deserves 5%, but how much we spend on it varies. Shoot for 5%. This differs with a single person and a family of 8. Dining out may fall here or discretionary, but it will eat up the budget pretty quickly.
Discretionary spending is another 10%. This category is usually spent on non-essential items, but can be used to pad other sections of the budget. Think clothes, entertainment, or vices. This is a first-world country where most of use have greater than 2 pants and 5 shirts, so we don’t really “need” anymore clothing, but that doesn’t stop us. I mean, I spend more time in hospital-provided surgical scrubs than anything else.
Miscellaneous spending of 5% remains. If it is an odd duck item, it goes here. If everything fits in a category, add this money elsewhere.
Adjust these values as you see fit. Categories such as “investing” should only be increased. Other areas such as housing may increase or decrease depending on your situation and priorities. That being said, DO NOT take money from “investing” to cover a nice house. The investment money needs to go towards debt or investments every month. Do not compromise here. Take money from “vehicles” if you drive a paid off vehicle. Slide the “discretionary” spending up to housing to make the difference. Be flexible where you are able. These numbers are guidelines to keep you in check.
Summary:
Investing/Debt pay down/Saving - 25%+
Housing - 25%
Transportation - 10%
Utilities/Internet/phone - 10%
Insurance/taxes - 10%
Food - 5%
Discretionary - 10%
Miscellaneous - 5%