Wednesday, August 06, 2008

A 60/40 Approach to Budgeting Money

In To Budget or Not to Budget..., I wrote that "we use budget-free money management." Our approach to "budgeting" was to save money first, then set aside money for future expenses (e.g. major home repair or improvements, new car, property taxes) and spend the rest. To quantify the allocation, I looked at the approximate percentages just prior to retiring in my forties in 2007. For reference, the percentages are based on net take home pay, i.e. after taxes.

  • Savings (24%) - We followed the principle of "pay ourselves first." Using automatic payments, a fixed amount was transferred from our checking account to our savings accounts within a couples days of receiving my direct deposit paycheck. The savings were to be used for future retirement and college for our daughter. We avoided using this savings for current expenses, no matter how large.

  • Savings for large expenses (16%) - We also saved separately for large expenses, both expected and unexpected, by depositing money in another savings account. Examples of large expenses include major home repairs, such as a new roof or new furnace, property taxes, new car, new furniture and yearly insurance premiums. To note, some of these expenses were yearly, e.g. property tax, and some were very infrequent, e.g. new roof. Therefore, this account grew every year, until the major expense happened.

  • Living expenses (60%) - The remaining amount in our checking account was used for monthly expenses, which include our mortgage, food, entertainment, clothing, routine maintenance (car and home), monthly health and life insurance premiums, and utilities.

    In this category, we allowed ourselves to spend as needed without a budget. Of course, many expenses were already pre-determined, e.g. utilities. In the months we underspent, we rolled the money into the next month giving us a buffer, in case we overspent slightly in a future month.

    In theory, once all the money was spent, we would stop spending. Practically, we always had a buffer of at least 1/2 months expenses in our checking account.

  • For reference, the percentages do not apply to earlier years, because we evolved over time to this allocation and I no longer have the records to track previous years. However, this allocation has became habit. Even in retirement, we are routinely spending about the same amount as the 60% for livings expenses when I was working.

    For more on The Practice of Personal Finance, check back every Wednesday for a new segment.

    This is not financial advice. Please consult a professional advisor.

    Copyright © 2008 Achievement Catalyst, LLC

    1 comment:

    Michael Musselman said...

    Great approach. If you are ever going to save any money you have to have a plan and that plan usually involves saving first and spending last. Unfortunately we have a culture that spends first and saves whatever they have left.