I'm not a fan of budgets. Even before I became a money writer, I found budgets onerous. Their prescriptions sometimes seemed arbitrary — why this much for groceries and that much for entertainment? — and they didn't do a good job of taking into account personal differences.
During a decade of writing about money, I've come to like budgets even less. They lead people to the mistaken belief that there's only one right way to handle money, a concept I hate.
That said, there are certain budgets that I do like.
- I like descriptive budgets. These aren't spending plans designed to tell you where your money ought to go, but actual information about the spending habits of a particular population. Descriptive budgets aren't meant to be followed. They describe what actually occurs in real life instead of promoting a particular ideal.
- I like budget frameworks. Budgets fail because they're overly detailed and complicated, because they don't reflect reality, and because they don't reflect your values. Budget frameworks avoid these problems by looking only at the Big Picture instead of trying to focus on narrow spending categories. They offer guidelines rather than rules.
My favorite descriptive budget comes from the Consumer Expenditure Survey, which looks at the money habits of average Americans. I feel like it provides a reasonable baseline for analyzing typical spending habits.
For instance, here's how the average American household spent its money in 2014:
- 33.3% went to housing (including utilities)
- 17.0% went to transportation
- 12.6% of spending went to food (7.4% was spent on food at home, 5.2% was spen on food away from home)
- 8.0% went to healthcare (including health insurance)
- 5.1% went to entertainment (of which 1.2% went to pets)
- 3.3% went to clothing
- 2.3% went to education
Again, this info isn't useful for making decisions with your life, but it's a good starting point for looking at what is (and isn't) normal.
The Balanced Money Formula
I've looked at a lot of broad budget frameworks in the past ten years, but my favorite remains the Balanced Money Formula from Elizabeth Warren and Amelia Tyagi. In their book All Your Worth, Warren and Tyagi argue that in order to achieve financial balance, your after-tax spending should be allocated like this:
- At least 20% should go to Saving (which includes debt reduction).
- No more than 50% should be allocated to Needs (which includes housing, utilities, healthcare, basic food, and basic clothing).
- The rest — around 30% — should go to Wants (which is everything else).
The downsides of saving too little should be obvious to Money Boss readers. If you don't build a nest egg, your financial future is bleak and at the mercy of outside forces.
Warren and Tyagi are adamant that less than half your budget should go to Needs. If you pour too much toward necessities, you don't have room in your budget for fun or the future. Unfortunately, too many Americans spend 60% or 70% or more on Needs, which makes them feel as if they're victims of circumstance.
The authors are just as insistent that you should build room into your budget for Wants. “You should ask yourself,” they write, “are you making enough room for fun?” There are people who can afford to spend more on Wants but — due to a scarcity mindset or something else — are afraid to open the pursestrings.
In the olden days, I was a vocal advocate for the Balanced Money Formula. I still think it's a great target for folks who are just starting to take control of their financial situation. If you're in debt or you're struggling to make ends meet, you should absolutely aim for this split.
But you know what? I no longer think the Balanced Money Formula goes far enough. It'll help you get on your feet, sure, and it'll allow you to save for the long term. But it still asks you to spend forty years in the rat race. I think there's a better way.
The Money Boss Budget
More and more, I'm an advocate of what we might call the Money Boss Budget. Its core tenet is: Save half your income. That's it. Save half. I don't care what you do with the rest of your money, but 50% of your after-tax income should be saved for retirement (or other long-term goals). I think most money bosses should aim for this sort of split:
- At last 50% to Saving (including debt reduction).
- No more than 30% to Needs.
- The rest — around 20% — to Wants.
It's tough to sell this idea. I hear a lot of objections to saving half your income. Really, though, most of them boil down to “I'm not willing”. There are plenty of folks in the leanFIRE movement who plan to retire with annual expenses of $40,000 or $30,000 or $20,000 — or less. Saving half is very, very possible, especially on an average American income.
Still, while I think it's possible for most families to follow the Balanced Money Formula with little modification to their lifestyle, I recognize that the Money Boss Budget is more challenging. The Wants spending isn't bad. I mean, the average American family currently spends 28% of its budget on non-necessities, while Warren and Tyagi advise 30%. So, 20% is a reduction — but not a drastic one.
Instead, it's Needs spending that creates a problem. If the average American household currently spends 64% of its budget on Needs each month, it might be tough believing you can cut that in half. Heck, right now most Americans spend more on just one category — housing — than I want them to spend for all of their Needs combined!
Why aim for half? For one, it's an easy number to remember. Mr. Money Mustache recommends saving 64% (or more); I think 50% gets people to their goals quickly while also being easy to aim for. Saving half gives you flexibility in your life. You're able to make decisions without stressing about the financial consequences. With a 50% saving rate, your spending is likely sustainable even if something goes terribly wrong. Finally, saving half teaches you to value your money.
Building Financial Confidence
Naturally, I don't expect anyone to get to a 50% saving rate overnight. If you're the average American, you can't move from 64% Needs spending to 30% Needs spending instantaneously. It'll take time. That's okay. Start by aiming at the Balanced Money Formula. Once you've reached that, focus on 10% increments.
Here's what I mean:
- The average household spends 64% of its budget on Needs, 8% on Saving, and 28% on Wants.
- The Balanced Money Formula suggests spending 50% of your budget on Needs, 20% on Saving, and 30% on Wants. This should be totally doable for almost everyone.
- A good next step would be to aim for 45% of your budget to Needs, 30% to Saving, and 25% to Wants.
- Next you might try to reach 40% for Needs, 40% for Saving, and 20% for Wants. Once you get here, there's no need to drop your Wants spending anymore.
- The final step would be to reach the Money Boss Budget guidelines of 30% to Needs, 50% to Saving, and 20% to Wants.
Let's say you start in the average position. You spend a year shifting things to achieve a 50/20/30 split. Great! Now challenge yourself to boost your saving (and debt reduction) from 20% of your budget to 30%. Trim some from Needs and Wants. Once you get to 30% saving rate, aim for 40%. At the same time, drop your discretionary spending down to 20%, which is the long-term target under the Money Boss Budget. If you can reach a 40/40/20 split, that's huge!
Note that the Money Boss Budget is meant for the wealth accumulation phase of your life. Once you've reached Financial Independence, after you've retired, then you enter the wealth preservation stage of money management. There, your spending looks very different. (Little, if anything, goes to Saving — because your nest egg becomes your source of income.)
Today, in 2016, I'm still not a fan of budgets. There are indeed times I'll track my own spending so that I can get a realistic idea of where my money goes — in fact, that's one of my projects for 2017 — but I chafe at the prescriptive nature of traditional spending plans. That said, I think almost everyone should be aware of how much they spend on Needs, Wants, and Saving. And I think more Americans should strive to save half their income.
As you flex your money muscles, cutting costs and boosting income, you'll build financial confidence. As you discover you can pay off debt and increase savings, your other financial goals will seem less intimidating. Each financial accomplishment creates the confidence to propel you to the next.
While the Money Boss Budget might seem impossible now, it won't seem nearly as unreachable once you've maintained the Balanced Money Formula for a while. If fifty percent seems impossible, don't focus on fifty percent. Start small. Make positive moves. Build wealth.
Do you budget? Why or why not? What's the basis for your budget? And, more to the point, what is your saving rate? After all, personal profit is the single best measure of how efficiently you're moving toward your goals — financial and otherwise.
Author: J.D. Roth
In 2006, J.D. founded Get Rich Slowly to document his quest to get out of debt. Over time, he learned how to save and how to invest. Today, he's managed to reach early retirement! He wants to help you master your money — and your life. No scams. No gimmicks. Just smart money advice to help you reach your goals.
I don’t budget but I do save half. Actually, my average savings rate is about 60%. I agree with you that budgets are onerous and over complicated – at least for me. Instead of budgeting I employ two strategies that keep my spending in check 1) I focus on minimizing fixed costs. Eliminating or minimizing a fixed cost is a decision you make one time that pays you dividends every single month. It also creates more space in your budget for other items that save you from feeling deprived. You don’t have to worry too much about the occasional espresso… Read more »
Does “savings” = pre and post tax retirement $ + post tax $ in savings account?
Oops. Sorry. I usually remember to mention which numbers I’m using. In this case, all numbers are after tax.
What about things like health insurance when computing savings rate? I’m enrolled in that automatically by my employer so not quite sure whether to count it as spending (needs?) or take it out of the equation (almost like it’s a tax).
We’re on the same page, Boss. I pitched a guest post to J$ entitled “No. Budgets are Not Sexy.” For some odd reason, it didn’t make the cut, but I published it and he did help promote it. Peculiar, I know. I am mindful of my spending, but don’t use a budget. I tracked spending for an entire year for the first time ever. The descriptive budget, if you will. $74,000 over the last 12 months, but on pace for about $60,000 this calendar year. I pay about twice that in taxes, and save more than triple. One of my… Read more »
Why will you be dismissed? I understand the gut reaction, but what is the justification? Just that they earned it and they want to spend it? Because half of their take home pay is still a chunk of money larger than may professionals manage to live on, so I’m not sure what additional expenses are really necessary.
Honestly, I think it boils down to personality. People who go into high paying careers are often looking for the high life to go with it, not to retire early on a modest lifestyle. One thing I’ve learned watching the blue collar versus highly paid white collar dynamic in my family is that money doesn’t really make people happier or better people. Some people are fulfilled with a modest lifestyle. Others feel they need the “good life” to be fulfilled. I try not to judge people’s spending or what makes them happy, but I have seen that it’s easier to… Read more »
I guess I don’t think of the balanced money formula or similar guidelines as budgets. They are targets for you to consider when you create your budget, but I thought that by definition your budget is something personal that you create, not something that is prescribed to you. Maybe there is another term for what I’m thinking of. That said, I don’t budget because I don’t track my spending. Oops. I like the idea of a 50% savings rate and for me I think it’s achievable. I need to go back and see what savings rate I am achieving this… Read more »
Hi Money Boss, I’ve been trying to calculate my own % of Wants, Needs and Savings. One thing that I’m unsure of is how to break down an investment property in which I live. It has 3 units and I live in one of them. It seems to me like it would be simultaneously a “Needs” and a “Savings”. Do I add up all spending for mortgage and expenses and then split it with 2/3 being savings (as an investment) and 1/3 being “Needs” (lodging) or would it be better to figure out a normal rent price for my unit… Read more »
This year will be the first year I save 50% of my take-home pay. It’s not easy to do, especially if you are maxing out all tax advantaged accounts as well! But once you get there the ball starts rolling, fast!
Not my site, not my rules, but I believe you should be allowed to include tax deferred savings in the savings column. The math might require a spreadsheet, or at least a calculator, but 401(k), HSA, etc… should be included as both compensation and savings. In other words, that money belongs in both the numerator and denominator.
Ugh, I’m in the category that you mention of spending more on housing than you’d like on all of our needs combined! 60% needs, 25% savings, 15% wants for us. I do think that for people with larger homes than they might need, you could almost shift some of that cost from “need” to “want”, because that where it belongs.
My budget was closer to the 60% savings level when I was working. Allowed me to retire much earlier than my peers
Thanks for another thought provoking article, J.D.! I did some rough calculations and my savings rate is currently somewhere between 50-60%, most of which is going to student loan debt at the moment. But it’s nice to see that number in print as I’ve been taking the steps you mention in your post. I certainly didn’t start out at this level, so it’s great to see how far I’ve come! And the variation in rate is due to the fact that I try to throw as much money toward my debt as possible, so that fluctuates month-to-month and I decided… Read more »
So I did a quick and dirty analysis, but it was based on Gross income and 31% is going toward payroll taxes. Ouch. I am hitting the Balanced Budget distribution. So now looking at Net – 29% is savings, 30% “Needs”, 41% “Wants”. Now, I have a 16 Yo son in a private school and into music. I put those costs in wants (9% of net income). In needs is an elevated transportation expense for 3 cars (1 car payment, maintenance), insurance for a male teen and occasional help paying for repairs on older son’s car. Those will go down… Read more »
I never used to budget, and I got by just fine during my working years. But now that I’m retired I feel the need to control what goes out because there is no more coming in (earned income, that is). I have found that YNAB does the trick for me. I can even say that I enjoy it.
I don’t like budget either. It’s too much work for me. We have a monthly spending budget of $4,500 and we try to keep it below that line. That’s the level of spending that we’re comfortable with. Currently, we save about the same amount every month, but it will go way down when Mrs. RB40 retires.
When I was working, we saved quite a bit more than our spending.
I guess I shall be the lone voice for the budget. I love mine. It serves so many functions and answers so many questions: *If I quit my job what would our spending and saving look like (a big deal with little ones or considering having another baby)? *What IS our total savings rate? How does it compare to our other expenses? *It helps me understand how semi-annual expenses break out as semi-monthly expenses. *It is also a critical point for negotiating with my less than frugal spouse. We can agree on $300 for his house projects every month and… Read more »
I would add that a budget is also just a reverse of spending analysis/review. I don’t go back and review my spending if I already know where it was going in the first place. Many of you are budgeting, just in reverse. You review your money after it’s gone to make sure it’s staying within your principles. I don’t have to do that, it would be redundant. As such I also don’t have to worry about what all that money Mint told me I spent at Walmart actually bought me, because I was conscious of it before hand and divided… Read more »
Interesting. I like the way you’ve framed that, Shara: “budgeting in reverse”. Even when we don’t budget in advance, we have spending targets. We’re just checking to be sure we’ve hit them in retrospect. I’ll have to remember that…
All your spending targets are is a budget. You’re just so comfortable with your budget that you are able to stay on it automatically, which is a synergy between behavior and goals. I mean what did you do when you took control of your finances? 1) You analyzed your spending until you understood where your money was going. 2) You realized which numbers were unreasonable and where you wanted to change. 3) You stated your new goals and stuck to them. 4) What were changes are now habits of how you live your life. I’m sorry to tell you JD:… Read more »
Would love to see a blog post on this debate 🙂 I enjoy seeing these two perspectives.
I realized today that the entire reason I plan to track my spending in 2017 is because after spending 2015 and 2016 mostly on the road, I don’t feel as if my spending does match my goals. I need to first get a snapshot of where my spending really is (which I’ll do in December), then spend a few months (probably the entire year) making adjustments to whatever is out of line. (I suspect I’m spending too much on food right now. Well, more than suspect. I’m sure of it.) Anyhow, just another way of saying that I feel like… Read more »
Gee, that sounds like a lot of work. ;p
I thought I was spending too much on food. Then I realized my husband eats like a horse, a healthy horse, but a horse none the less. If you’re interested I could outline it for you. He’s an interesting case of supporting my FI goals until he has reached his discomfort threshold.
Here’s the problem I have… I am currently saving 40% of my take home pay but a portion of that is ear marked for a cruise for my 50th birthday in a 20 months. I have a really hard time shaving my spending down more though. When I found out I had ovarian cancer in 2013 and did not know what my diagnosis was, I had a few moments of “But I didn’t get to ______ yet!”. Now that I am a survivor, I don’t want to wait on enjoying life’s moments like being a Disneyland Annual Passholder, or running… Read more »
Yeah, your comment gets at what I view as the fundamental problem of personal finance: We don’t know how long we’ll live. I always say that if we knew when we were going to die, all of this would be so much easier. If I know I’m going to die at age 56, for instance, then I can better balance the needs of today and tomorrow. But we don’t know what our future holds, so we’re always having to make best guesses. If I die tomorrow, then I have a bunch of money that I could have been using to… Read more »
I budget because it helps us stay on track with priorities. My husband and I are not high earners–I’m in social services and his earnings are similar–but I could see a budget being less necessary as earnings get higher, simply because there’s more overall wiggle room if you have an off month. I aim to keep our budget as simple as possible, and in it’s currently iteration, there are 10 categories to cover different kinds of spending. We budget 40% for saving, but if we don’t spend all the money we budgeted for spending, some of it will get moved… Read more »
I’ve always been one of those save 50% of gross type of guys. You mention you no longer save when you are in the preservations stage. I have always looked at retirement as the point in time where your liquid investments equal or exceed 25 times your spending. By this definition you can still be gainfully employed (probably your own business or income properties) and retired at the same time. In retirement, even the tradition “out with the job/business” kind, you still have income in the form of interest, dividends, rent income, capital gains, and all the miscellaneous streams of… Read more »
Hi J. D.,
Quick question: In the article you quote from the Consumer Expenditure Survey and how Americans spent their money in 2014. The numbers you quote add up to only just a bit over 80% (81.60% to be precise) – which means that there’s quite some money left over. How was this money spent?
Regards, Pinch
I don’t have that info off the top of my head, but if you follow the links you can find that info either in my write-up from April or at the Consumer Expenditure Survey website. If I recall correctly, the answer is “piddly stuff”. Half a percent for tobacco, some amount on personal grooming, and so on.
I respectively disagree. Setting a budget and tracking expenses keeps me on track on income and expenditures. I like having a window, otherwise I might stray away from my goals.
I am not a high earner (less than 40k) so I need to budget. It really helps me break down yearly expenses into small monthly amounts (like car insurance) instead of having to pay extra transaction fees by paying monthly. Using YNAB for the past two years, I now have a 1-month buffer, am working on building a small emergency fund, contributing to my 401k (5%, it’s small but it’s a start), and am opening an IRA next month. Maybe one day, I’ll have enough income where I won’t need to budget, but starting out, it’s super necessary.
I hear you on the small income – there’s just no way for me to save half my after-tax income…it’s just not possible to live on $18,000/year in this city (and I know this because I tried when I was just starting out in my career – for those of you who say I didn’t try hard enough: I lived in a house with 16 roommates, cooked every single meal at home from scratch, had no tv, no internet, gave up alcohol, and used the library)but if I relocate to a different city, my earning power drops through the floor,… Read more »
JD, like the way you think man, it makes so much damn cents (or sense even 😉 haha)..
It’s really inspiring to see the way you break it down and interested to know if this is the way you did it yourself?
Sure it was although am interested!
Cheers for writing this
I agree with the goal of 50% savings and have been aiming for that personally. So question to everyone: Where I live (Japan), health insurance is national and the rate is tied to income, so I’ve been treating it as a tax in my calculations for savings rates. I know it won’t go away totally if I didn’t have any income, but I definitely can’t use the current numbers to judge what I’ll be charged if I retired. I’m also self-employed, so can’t just go by take-home pay or anything. How would you handle that, both for tracking monthly savings… Read more »
I think it ultimately doesn’t matter if it is a tax or a bill. What matters is: are you comfortable with what you are saving? Is it leading you to your goal on a timeline you are comfortable with? Could you be saving any more while still maintaining a comfortable lifestyle? It ultimately isn’t about a 45%, 49%, 50% or 55% savings rate. It’s about living a good life on a budget well below your income that is leading you toward financial independence. If there is an expense you can cut and not miss, or an efficiency you haven’t noticed… Read more »
My savings is mainly debt reduction right now. Student debt and other loans take 50% of my money most months. Once those are knocked down. My needs with my wants spending should hover around 50%, which will be amazing. Debt reduction will switch to investment savings.
After working for several years with good paying jobs (and falling into the about 50% savings rate group), my husband and I took off for a 10 month rock climbing trip with 2 of those months in Europe. Since we are both naturally pretty frugal, we never kept a budget.
However in Europe, we found that keeping a budget actually allowed us to give ourselves permission to spend money to take full advantage of the experience. Our budget was 50€ on climbing days and 100€ on touring days (4:1 ratio)
I read that book several years ago and found it to be an unrealistic Fail. It’s simply absurd to expect a person living on a poverty-level income to spend no more than 50% of their income on needs, especially if they are paying market rent for housing. I sequentially rent crummy rooms in overcrowded houses – living with drunks, druggies, growers, dealers, sex offenders, and SSI recipients – and shelter consistently consumes at least half my income.