Investing Basics: 3 Budget Plans to Help You Live Your Best Life & Achieve Your Goals
This is the first blog post in our series of Investing Basics. On the first Monday of each month in 2019, I will be discussing a relatively basic Investing topic. If you don’t know a whole lot about investing, this is the right series for you! If you do know a lot about investing, this is also the right series for you as you might learn something new or remember something you’ve forgotten.
The first topic in our Investing Basics series is Budgeting.
You may be thinking, “Hey, I came here to learn about Investing not Budgeting.”
The answer is simple: you can’t start investing without a proper budget in place. Creating a realistic budget and adhering to it allows you to pay for core living costs, afford things you need, pay off debts, and even save.
We’ll talk about the 50/30/20 rule, the 70/15/15 rule, and the 80/20 rule.
Table of Contents
Investing Basics: 3 Budget Plans to Help You Live Your Best Life
First Things First
Calculate Your After-Tax Income
Your after-tax or net income is how much you earn after taxes are taken out of your paycheck. These taxes include state tax, local tax, income tax, Medicare, and Social Security.
If you’re an employee who earns a steady paycheck, your after-tax income can be found on your paystub. If you have any deductions taken out such as retirement, health insurance, etc be sure to add those back when calculating your after-tax income.
If you’re self-employed, i.e., you are self-employed as a sole-proprietorship, and/or independent contractor, or a freelancer and earn $400 or more, then finding your after-tax income is a little harder.
You need to take your gross income then subtract your business expenses and the amount of money you set aside for taxes. You also have to account for the Self-Employment Tax. The Self-Employment Tax is double what you would pay in Social Security and Medicare if you were not Self-Employed.
Note: You have to pay double for Social Security and Medicare because if you were employed by a company, your employer would pay the other half of Social Security and Medicare. Because you are the Employer and the Employee, you have to pay both parts.
Once you have that figured out, the next step is to find the right budget option for you.
1. 50/30/20 Rule
A pretty standard Rule of Thumb for budgeting is the 50/30/20 Rule. Harvard economist Elizabeth Warren, and her daughter, Amelia Warren Tyagi, first coined this phrase in 2005 in their book, “All Your Worth: The Ultimate Lifetime Money Plan.”
So how does this rule work?
50% of your budget should go towards essentials.
- Car Payments
- Credit Card Payments
Essentials are the things you absolutely need in your life. It is not essential if getting rid of it will only cause minor inconveniences in your life. Netflix subscription? Not essential. A car to get to and from work in the massive state of Texas where public transportation is not a strong suit? Essential. Insurance for that car? Essential. New $200 shoes when you have a closet full of perfectly good shoes at home? Cute, but not Essential.
30% of your after-tax income should go to wants.
This is the fun part! And the not-so-fun part.
You can use this 30% on anything you want. Cable? Yes! Vacations? Yep! That Starbucks latte every morning? You bet!
It just has to fit into this 30%. It’s harder than it sounds.
But this also gives you an opportunity to figure out the things you really want in your life, and the things you just kind of want ‘just because’.
If that ‘wants because’ does not exceed 30% – go for it. If it does then you either have to forgo it or save for it.
This brings me to the last section of our 50/30/20 Rule.
20% of your budget should go to savings.
- Emergency Fund
- Paying off Debt
- Retirement Funds
- Roth IRAs
- Other Qualified Retirement Plans
- Taxable Accounts
Paying off debt, as a lot of us know, is really hard. We want to use that money toward our wants, needs, and retirement savings. But it’s important that you chip away at that debt each and every month you can.
It’s also important to note that while you are paying off your debt, you should also be putting money into an emergency fund. This emergency fund is super important because if anything major happens and you need cash fast… without an emergency fund, you are stuck. You should aim to have at least 3 months’ worth of living expenses in your emergency fund and ideally, we recommend you have about 2 years’ worth of living expenses saved.
So don’t get so caught up in paying off your debt only, pay yourself too.
If you look at this Budget Rule, and you think, “Sounds good, but there’s no way I can swing that.”
Well, I have two more options for you!
2. 70/15/15 Rule
Financial Expert, Nicole Lapin coined the Budgeting Strategy of 70/15/15 in her book, “Rich Bitch: A Simple 12-Step Plan for Getting Your Financial Life Together… Finally.”
She suggests that your Essentials should be about 70% of your budget and your Extras and Savings should each be 15%.
This is a great plan if you live in a city where the cost of living is high or if you and your family’s essentials are just more than 50% of your budget.
The essentials stay the same as in the previous Rule except you can add paying down debt as apart of that 70%.
15% should go to your emergency fund (which, again is very important to build up), and any retirement accounts you have.
Unfortunately, with this plan, your wants are limited to only 15% of your budget, but you’re better able to determine what you actually want rather than those ‘want because’ items.
These Budget Plans are great if you like tracking your spending. But if you’re the type of person who can’t stand the thought of tracking where every single penny goes, well there’s a plan for you too!
3. The 80/20 Rule
This Rule was first introduced by Italian economist Vilfredo Pareto.
This Rule is super simple. 80% of your budget goes wherever you want/need it to go AS LONG AS the other 20% is being saved. Again, those savings should first go towards your emergency fund and then towards retirement savings.
Once you get good at the 80/20 rule, try making it the 75/25 Rule and keep going, then maybe make it the 70/30 Rule and so on and so forth. This also applies to all the rules above.
It’s important to remember the bigger picture for saving and investing basics: yes, of course, you need money to pay for any mishap that will surely happen in your life, but you’re putting money aside so that one day you can retire comfortably.
A mantra that is always heard here at Hamilton Financial Planning: Save More, Spend Less. If that sounds easier said than done and you would like some help with creating a proper and sustainable budget, Financial Plan and Investment Management, book a Get Acquainted meeting today!
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Scott Hamilton is the founder and chief financial officer at Hamilton Financial Planning, a wealth management firm that specializes in providing comprehensive financial planning for retirees in Dallas, Houston, and Austin, Texas. With over 20 years of experience in the financial industry, and has completed over 250 financial plans for retirees across all industries, but mostly the oil and gas industry, Scott is passionate about providing his clients with the tools and insight they need to achieve their financial goals.
He has a Bachelor of Business Administration in finance from Texas State University and an MBA in international finance from Pepperdine University. Scott has also been happily married to his wife, Gayle, for over 25 years. To learn more about Scott, connect with him on LinkedIn.