Financial Rule of Thumb: Create a Livable Budget

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I've been evaluating several financial rules of thumb in this series. It's hard to imagine something else as beneficial as an easy-to-execute method for managing your cash flow. In simple terms: a straight-forward way to budget.

Efficiently and effectively allocating your income to maintain your lifestyle and accomplish your goals is the starting point on the road to financial security.

Without outside input, it can be hard to determine whether you're spending too much in any one area of your life. A spot-on rule of thumb could be ideal for helping you get or stay on track with your spending.

Rule of Thumb: Spend 50% of your money on needs, 30% on wants and 20% on savings (50/30/20).

Why: The golden rule of personal finance, and one of the elements of USAA's core advice, is "spend less than you earn." That's easier said than done. The Three Generations survey conducted by the Association of Young Americans and AARP last fall indicates that more than half of Americans are doing exactly the opposite. A budgeting process that enables you to live that golden rule and build for the future via saving and investing is a must.

Assessment: Anything that can turn "budget" from a grind into something actionable and easy is a win in my book. Whether its 50/30/20 or 80/10/10 or any of the other rules of thumb designed to provide broad guidance to your spending, I'm all for it. What I like about most of these budgeting rules of thumb is that they include an element of saving. With a personal savings rate that has hovered close to 5% over the last decade, this is a good thing.

There are, however, potential potholes with this approach. One is the question of where you apply the spending percentages. From my perspective, looking at expenses as a percentage of gross (before tax) income provides the clearest barometer on your spending. Net income might reflect tax withholding that is grossly high (you get a big tax refund each year) or low (you're writing a check each April). Saving based on net income could cause you to omit your 401(k) from your calculations (which wouldn't necessarily be bad). Net income figures remove other expenses from your calculations (health insurance, group life insurance, allotments, etc.).

Regardless, these rules offer a broad measuring stick of where our money should be going. Too often, people I speak with have no idea if what they are spending is reasonable or over the top.

My preference would be to dig a bit deeper and explore questions like: How much are you spending on that big truck in the driveway? Does $200 of coffee a month really make sense?

In the end, I can't throw shade at a rule of thumb that helps folks get a handle on their spending. Budgets aren't exciting, but they are a responsible thing to do.

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Personal Finance