Photo credit: Louis Leray
Many people think budgets are about deprivation. As a financial advisor, I feel they are about liberation. Here’s a simple three-step plan to create a budget that you will feel excited to follow.
Step #1: Understand the real purpose of a budget.
It’s not necessarily what you might think. The benefit of a budget is that it establishes boundaries. Importantly, these boundaries can set you free to focus on what is most essential. Let me explain. Because we live in a world with so many choices, people often think of budgeting as a constraining, joy-restricting activity. But when done correctly, budgeting actually creates a protective financial haven around you (by simplifying your set of choices) to help you make spending decisions that will enhance your joy.
Step #2: Learn what healthy spending looks like.
If you ask the average person, “What is a healthy mix between spending on needs and wants versus savings?” you will likely get a blank stare. That’s because very few of us were ever given straightforward guidelines to follow in this area.
Back in the early 1990s when she was a Harvard Law School professor specializing in bankruptcy, Senator Elizabeth Warren and her daughter Amelia wrote a delightful book called ALL YOUR WORTH. In it, they identified an optimal “balanced spending formula” of 50/30/20. It is simple, powerful, and after all these years it’s still the most effective healthy spending rule of thumb I’ve come across.
The “Balanced Spending Formula” Looks Like This…
• 50 percent – the ideal amount of your take-home pay that goes toward needs
• 30 percent – the ideal amount of your take-home pay that goes to wants
• 20 percent – the ideal amount you set aside for savings
Step #3: Adjust to fit your specific situation.
While I agree that 20 percent is the ideal amount to strive to save, in this era of sky-high student loans and above average unemployment it may not be obtainable for many people right now.
For this reason, I have temporarily adjusted my thinking. Any amount you are paying for reducing student loan debt or credit card debt counts toward that 20 percent savings, if you will commit to channeling those dollars into savings after the debt is paid off.
Setting up a healthy budget with this ideal spending formula empowers you to take the first step in creating a life lived from a place of financial strength. It enables you to find that vital intersection between what is important and what you can control. Focus on that sweet spot and find your joy.