The perfect way to allocate your spending?

I saw this on Get Rich Slowly and wonder what you think of it?

Since I didn’t allocate my own spending this way ‘on the way up’, I can’t comment either way … but, maybe some of you can?

Here’s how it works:

You take your After Tax income and divide it into three categories:

1. Needs – These are you ‘must haves’ i.e. things that you can’t go without: rent/mortgage; car; electricity; basic food (the book provides a ‘rule of thumb’ for this); and, so on.

You allocate 50% of your after tax income to these needs; given that we already have the 25% Income Rule (spend no more than 25% of your after tax income on rent/mortgage) that leaves 25% on all the other ‘needs’.

2. Wants – According to the book, you should have fun – and, budget 30% of your after-tax income for it. I happen to be of the same mindset … what is money, if not for spending (except that you must do it in a way that allows you to live your Life’s Purpose by your desired Date). 

According to the book, ‘wants’ include additional food (i.e. lamb chops instead of dog food?), your cable TV and internet (these are definite needs for me, especially on my 100″ home theater screen … but, I can afford it!); trips and vacations; and, so on.

3. Savings – that leaves (or should leave) 20% of your after-tax income for your 401k investments and other savings/investment … since this is 5% to 10% more than most authors suggest, I commend it. Just remember, that even with 20% you’re not going to be able to save your way to wealth.

All in all, it seems like a pretty good savings plan to me … what improvements would you make?

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7 thoughts on “The perfect way to allocate your spending?

  1. Of course saving 20% is good if you can do it(which it is doable).

    But always shoot for more. If you can save 90% spend 5% on needs and wants each. The best way is to make more while not significantly increasing your spending IMO.

  2. I think it’s a pretty decent guideline, however, I feel that it can easily be income based. Probably a more realistic way to do it is to further break down the savings percentages based on income brackets.

    I would have to play around with the numbers a bit, but perhaps up to 30k/year one should be able to squeeze at least up to 10% of their after tax income into savings(their really not paying tax up to that income level and virtually all of their tax return should to to savings), then maybe up to 50k/year that percentage should easily move up to 15% and then as you move above 50k/year in income, one should put away 20%. Just an idea.

  3. I calculated that right now we are saving about one-third of our take home pay on average, but on really good months, it moves up above that because I keep our living expenses and lifestyle the same, regardless of how good a month I have. But when we were living on rice and beans when I was in college, we were lucky to pay the rent, utilites, gas, etc… and still put food on the table. 20% would have had to come from a second job. 😉

  4. I’d always heard “pay yourself first” meaning to set aside how much you want to save, and then automatically remove that from the income. One way is to deposit your check to savings, then transfer over to checking for what is needed. Reverse that and automatically transfer your set amount to savings (or 401k if taking out some before you see it).

    Then see how much house you can buy/rent with that. Most of the greed I see is in people buying the house they want and can get the loan folks to get them into (maximum payments), even using bonuses and overtime which are not necessarily going to happen again. They do this based on history and the fact that it is sometimes (for executives) a hefty part (1/3 or more) of their total income. Yet, when the economy started turning in on itself, the first things to go were overtime and bonuses. A little editorial here on why I think you should still pay yourself first.

    From that premise, decide how much you want to save and that will require you to know what you are saving for. Then you can go with the percentages not-to-exceed for your housing allowance. If you’re young and still have car payments that are a major part of your income, that’s another thing to consider. How much car?

    As Adrian pointed out, many luxuries are considered necessities. Perhaps a young engineer feels he needs a certain kind of car to reflect who he is so he can attract the mate he desires…only when he is older might he switch to a “family” vehicle. Insurance for some of those faster sportier cars will be higher as well. Yet, could he go without it? For him, it’s a want, really, as is the internet and cable tv and cell phones for most of us. For those whose livelihood and business depend on the internet, it’s a requirement. For those who must travel constantly in their jobs but also be reachable (did these jobs exist before cell phones?) then a cell phone is probably a requirement and less expensive than phone cards and stopping on the road to call and talk about stuff.

    Sometimes a need can be met with something less expensive that seems otherwise to be a luxury (as the case with the cell phone above). I think many people are re-evaluating their needs, but most will keep the electronic toys as long as possible. Need or want? Sometimes deciding which category something goes in is the hardest thing.

  5. @ Scott – Michael Masterson lists some income-based guidelines in his book:

    However, I see that as more ‘theoretical’: in an earlier post I suggested starting by saving (at least) 10% of your income [this meets your “pay yourself first” idea, Diane], then adding 50% of ALL future pay rises, ‘found money’ (loose pocket change, quitting smoking, selling quilts, small inheritances and lottery winnings, etc.) …

    …. this probably approximates Michael’s (and your!) guidelines, with the advantage of never requiring you to ‘pull back’ your lifestyle (rather, delaying gratification, which I find is easier psychologically).

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