As you know by now, I like to have guidelines to look at and compare my own personal finances to others and to recommendations by others. I also often like to ignore those recommendations and guidelines and do whatever I want. After all, it’s my money and my life and my priorities may be very different from someone else. One such guideline I look at (and often disregard) is recommended budget percentages. Experts (and non-experts too-ha!) suggest expense percentages based on your income. Mortgage companies have a limit on how much they will loan to you based on the percentage of monthly payment to your monthly income. Credit card and other loan companies look at your monthly debt payments to your total income to see if they want to extend credit to you.
Because most experts use take-home pay to suggest percentages for expenses, I have slightly adjusted those recommendations to include gross income (income before taxes and deductions) instead. I’ve said it before and I’ll say it again (probably too many times) that it doesn’t make any sense to ignore payroll taxes and payroll deductions as separate expenses in your budget. Especially when these deductions often make up 25-30% of your gross income!
A TOOL FOR RECOMMENDED MONTHLY BUDGET PERCENTAGES
I have a spreadsheet to share with you that directly matches the budget you set up in yesterday’s class PF104: Creating a Budget and Cash Flow Statement.
Here’s an example of the Smith family’s monthly budget percentage recommendations:
Since Jim’s income is variable from month to month, they used averages based on their annual budget they set up for 2016. Note that the largest differences between their budgeted amounts and the recommended guidelines are:
- retirement contributions at 0% versus the 5-10% recommendation
- savings at only 1.7% versus the 5-10% recommendation
- food expenses at over 13% versus the recommended 5-10% recommendation
- medical expenses at 4.67% versus the 3% recommendation without even including doctor visits covered by their HSA account (their health insurance is high but it’s unavoidable)
- debt payments at 8.37% versus the 3-8% recommendation (and that’s even with paying off one student loan this year)
STEPS FOR CALCULATING YOUR BUDGET PERCENTAGES
Let’s take it step by step if you’re interested in seeing how your budget measures up:
- ENTER PAYROLL INCOME & DEDUCTIONS. Use your pay statements or you most recent budget to enter all paycheck information as listed on the spreadsheet. If your income is variable, use a monthly average. If you have more than one income earner, you will need to combine them together.
- ENTER OTHER INCOME ITEMS. Enter all other income items in the next section including interest & dividends, business income, rental properties, etc.
- ENTER SAVING & EXPENSE AMOUNTS. Using your budget or the budget you created in class PF104, enter (or copy and paste if you haven’t added or deleted any categories in the budget spreadsheet) all of your saving & expense amounts.
- ADJUST REMAINING AMOUNTS AS NEEDED. If you created a zero-based budget, your total percentage number should equal 100%. If it doesn’t equal 100%, adjust your savings amount for the extra so that the percentages equal 100%. If you don’t have a zero-based budget, a total percentage of less than 100% means you have more income to allocate to categories and a total percentage of more than 100% means you are spending more than you are earning (change your ways!).
- COMPARE SAVING & EXPENSE CATEGORIES TO RECOMMENDATIONS. Now you will want to compare your percentages based on your budget to the recommended amounts for each category to determine which categories in which you are spending significantly more or less than the recommended percentages.
- ADJUST YOUR BUDGET. If there are areas in your budget where you think you should improve, adjust your budget accordingly.
WHAT DO YOU LEARN ABOUT YOUR BUDGET?
It may be of special interest to you to look at your percentages of income that you are paying for FICA, federal and state taxes. In the Smith example above, they are paying approximately 16.75% of their income in federal, state and FICA taxes.
Hopefully this exercise is insightful into helping you determine a reasonable budget for you and your family and pinpoint some areas that may be a starting point for you to cut back on if that’s necessary for you to achieve your financial goals.