A Quick and Dirty Budget

Ah, the budget.  Everybody hates it.  Or so they say.

I used to, too, until I understood the degree of control (and peace of mind) that came with knowing exactly what was coming in and what was going out of my bank accounts.  (And the appreciation began at a painful time for me, when the outflow was still much larger than the inflow!)

The women who work with me to get their money under control fall into two camps:  either (1) they’re struggling seriously with out-of-balance outflow and inflow, where every cent counts; or (2) they have a respectable income but have some crazy spending patterns, usually as a result of some “money gremlins” left over from childhood.

The first group I call “Squeezing Blood Out of Stone.”  How they got into this predicament varies drastically.  It could be the result of a divorce or lost job that limits the inflow suddenly.  Or a major medical condition that wipes out all savings and requires ongoing payments.  Or it could be the accumulation of a long history of living beyond one’s means.

Whatever the cause, the first thing that has to change is a shift to total “open book” honesty.  No hiding anything.  It’s time for full examination of every single cent that flows in, and every single cent that flows out.  Knowing that detailed information often requires a 30-day exercise of recording every expenditure, plus reviewing bank statements, credit card statements, and so forth.

Once that’s done, the next step is to enter all the information on a detailed statement, or budget, such as the one that I make available in an article entitled “Your Money Is Just Like the Wizard of Oz.”  There you’ll find the link to a report called “Knowing Your Numbers:  The First Step to Financial Security.”  That’s my gift to you, and it tells you exactly how to proceed.

The second group I call “From Money Gremlins to Money Mastery.”  First we identify what unhealthy money behaviors are at play, and work to identify what might be causing them.  (More often than not, they are the result of childhood memories, real or imagined.)  And then we work to get rid of them … and the negative money behaviors disappear as well.

The next step of bringing money under control is to create a budget that brings stability and peace of mind.  But the question is:  how much money should be allocated to each budget category?  Women in this second group have income levels that vary widely, so it didn’t used to be easy to give a pat answer.

Today the formula I use is a brilliant one devised by Elizabeth Warren (a Harvard law professor with an expertise in personal bankruptcies) and her daughter, Amelia Warren Tyagi.  It has two major benefits:  (1) it works for incomes of all levels and (2) it allows you to live comfortably (albeit prudently) while building your financial security.

And it’s straightforward!  It’s called the 50/30/20 Balanced Money Formula and divides your expense categories into just three:  “must-haves,” “wants,” and “the rest.”

“Must-haves” get 50% of after-tax income.  “Wants” get 30%.  And the remaining 20% goes to savings and any debt repayment.

Let’s get into more detail.

First, let’s define “after-tax income.”  It’s your gross pay, less any taxes related to your wages.  These could include income tax withholdings, Social Security and Medicare taxes, state taxes, plus the alphabet soup of other disability/medical/other taxes.  What you don’t subtract are any contributions taken from your paycheck for 401(k) contributions, health insurance premiums, and union dues, for example.

Next, you target your “must-haves” to take up no more than 50% of your after-tax income.  These are all the things you’re contractually obligated to pay, such as child support or alimony, cell phones on term contracts, minimum payments on school or other loans, and credit-card minimums.  Add to that all the living necessities:  housing, food, transportation, utilities, insurance, and so forth.  To help you discriminate between must-haves and wants, your child’s required school uniforms are a must-have; new casual clothes are wants.  Having a land-line phone may be considered a must-have, but all the extra bells and whistles fall under wants.

Then tally up your “wants,” which shouldn’t add up to more than 30% of your after-tax income.  How you spend this money depends on what brings you the most joy in life, and rewards you for all your efforts.  After all, a girl’s gotta play!  Everyone will have a different idea of what that means: traveling, dining out, gifts, bling, whatever.  But there’s one cut-in-stone rule:  you cannot exceed the 30% maximum.  And if some kind of financial disaster hits, whether temporary or longer term, the wants are the first things to get cut.

Lastly, divvy up “the rest,” or 20% of your after-tax income, into savings and repaying any debts.  In my article Five Things a Girl Can’t Live Without, among the five things are a “get-out-of-debt” plan, a retirement account, and an emergency fund.  They’d come out of this part of the budget.  To clarify, while the minimum payment on existing credit card debt comes out of your must-haves because it’s an obligation, any payment above that comes from here.  But if you pay off your credit card each month (good for you!), that’s not debt.  You’d just allocate each item to its rightful category (must-haves or needs).

Now here’s the challenge.  This sounds simple.  It’s more difficult than you think because of how our lifestyles have evolved over time.  The hardest part will be getting your must-haves down to 50%.  But in this era of economic turmoil and uncertainty, this is what brings the greatest flexibility and tranquility.  By keeping the hard costs so low, in case of loss of income you can jettison all of the wants, savings, and debt repayment.  That would let you survive much longer on unemployment and emergency funds.

So what’s my recommendation?  First, guess what you think your percentages are.

Then sit down with paper and pencil this coming weekend.  Figure out your percentages as precisely as you can, without great effort.  If you’re out of balance, know that alignment is not something you can achieve overnight.

But give yourself the greatest gift known to (wo)man:  promise yourself to get the percentages aligned within the next 12 months, come hell or high water.  It’s your surest path to peace of mind.

Don’t forget to let me know in the comments section below what you think of this!

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Bio:  Sharon O’Day lost everything at age 53: her home, her business, everything. But how could that be? She’s an expert in global finance and marketing with an MBA from the Wharton School. She has worked with governments, corporations, and individuals … yes, she was the secret “weapon,” if you will, behind many individuals in high places. But yet she did! Since then, Sharon has interviewed countless women and done extensive research to understand how that could have happened, especially with her strong knowledge of numbers and finance.

Today her mission is to show as many women as possible how to become financially free for the long term, through her “Over Fifty and Financially Free” coaching sessions.  She has developed a step-by-step plan to get past all the obstacles that keep women broke and scared … and from reaching the financial peace of mind they so deserve.

  • Sondra

    First I thought, “Ugh! Who in their right mind, other than the President, would subject themselves to Budget Talks first thing on a Monday morning?!” And even he probably waits until after coffee. But then I remembered a recent breakthrough when I was frustrated with a reoccurring financial pattern in my life, sat down and stared it face to face, and realized a minor tweak I should have made years ago would have completely eliminated the reoccurring frustration. How empowering. As is the information you’ve shared here Sharon. Financial peace of mind is one of the greatest gifts there is.

    • Anonymous

      As I said to you elsewhere, Sondra, I wish I could make this sound like more fun.  But like some old-time medicines, you had to scrinch up your face and just swallow real fast … because it was so good for you.  This process is worth all the “scrinching” needed to get it done!

  • Wendy

    Hi Sharon;
    For me, there is a real sense of satisfaction that comes from the process of setting up a budget – the hardest part is managing it! 

    • Anonymous

      Wendy, you own a business, so you probably (hopefully?) do monthly accounting anyway.  So it’s a logical time to do your personal “accounting” as well.  And what I like about this 3-category budget is that you don’t need to micro-manage it.  So if you use some software or just an Excel spreadsheet, you only need three “buckets.”  And it’s easy to see each month if you’re within each bucket’s target percentage.  You only need to closely inspect if the “must-haves” or “wants” percentages of after-tax income go higher than they should be.  I love it!

  • Jen

    Great article Sharon!  Not only are the tips doable, but you explain them quite clearly.  Thanks so much for sharing!

    • Anonymous

      Thanks for the kind words, Jen.  The truth is that money and finance are not complicated.  People have just dressed them in complicated words.  Once you peel back those words, it’s all really straightforward!  Mostly just adding and subtracting …

  • Wil

    This article will help a lot of women. Women who are suddenly thrown into poverty or near poverty need to know what to do to survive, then prosper. Thanks for the article!

    • Anonymous

      Wil, all too many women aren’t given the financial tools to start with.  So they’re more vulnerable to life changes like divorce, job loss, and so forth.  This formula is a great place to start so they can be sure they’re taking care of themselves in the process.

  • Anonymous

    This article hits right on the necessary basics of balanced budgeting skills and techniques…hugely valuable to so many…could you send a copy of this to Washington? Great article as always Sharon!

    • Anonymous

      Denny, I called Geithner to ask for his email address.  He told me he was too busy making incorrect statements about how Standard & Poors would never lower the U.S. credit rating … and suggested I call Bernanke.  😉

  • AJ

    Great advice! Sometimes hard to follow, for me;0)
    Works great when I do!

    • Anonymous

      Thanks, AJ!  It works great for MOST people when they follow through … but that’s the tough part.  Following through.  Yet if you can trick yourself into making it a habit, suddenly every other part of your life gets so much easier …

  • This is great Sharon! I am with you, am on the quest to get out of debt. Love your specifics on how to do it, how to divvy up my money. Thank you so much!

    • Anonymous

      Elvie, especially as someone is trying to turn their finances around, this 50/30/20 formula gives you a solid direction (although it’s not so easy to get in place because our “50” portion is usually much larger to start).  And you don’t have to micro-manage each little line item … as long as the three big ones are in balance.  Hope it helps you!

  • Susan Kim

    I like this plan because it’s realistic– 30% for the wants. The trickier part is determining what’s a want vs a must have.  Food is a must have– but the heirloom tomatoes?  It can seem like a must have.

    • Anonymous

      Typically, Susan, “food as sustenance” is a must-have and “treats” are wants.  But I think that, once you put your spending into those three buckets, you can see if you need to cut it that fine.  If you do, then you need to choose whether it’s heirloom or plum in your next salad … 😉  I can tell you that, as I was rebuilding after my financial tsunami, I had green peppers for awhile, and not my very favorite yellow and orange ones!

  • Thanks for the great article Sharon. Budget is a word that no one wants to embrace, but clearly it is a word that can offer relief to people who need to get their financial house in order!

    • Anonymous

      Oh, a budget by any other name … Spending plan?  Money map?  Money plan?  In the end, it comes down to the same thing.  But sure feels good when you have one in place and you’re in control!  Thanks for the kind words, Michele.

  • Anonymous

    A great article, Sharon!  So much actionable information presented in an easy to understand format.  For many of us, struggling to balance the budget while remaining flexible as our personal circumstances and the economy demands, is an ongoing battle.  Thanks for great information about how to make the task manageable.

    • Dale, the greatest challenge is for entrepreneurs, especially those in start-ups, because of the volatility of their income.  Hopefully they kept their fixed costs low enough to weather that early period with grace and ease.  And, if not, with a lot of courage!

  • I’m looking forward to figuring out how close or far off I am from these percentages.

  • I’m looking forward to figuring out how close or far off I am from these percentages.

  • I’m looking forward to figuring out how close or far off I am from these percentages.

  • I’m looking forward to figuring out how close or far off I am from these percentages.

  • I’m looking forward to figuring out how close or far off I am from these percentages.

    • Lori, let us know when you find out!  Whatever you find, remember that they may not be something you can change overnight, especially the “must-haves” which include lots of contractual obligations.  But they CAN be changed with time, and it’s certainly worthwhile.

      • The experiment turned out really well actually. The must haves is right on ($16 less than 50% of our salaries). The wants is a lot less actually – yeah!
        This only worked out well because I just refinanced my house from a 15 yr to a 30 yr so the payments went down by $700. We decided to do this so we could save more for the kids’ education and get a large amount of money saved in the next few years.  We plan to move in 6-8 years after my step-kids graduate HS and we want to keep the house we are in to rent out.  So instead of paying it off as I was planning (pre-hubby and step-kids) we will need a pool of $ ready to go.I enjoyed this experiment and I will definitely use this going forward. (I always keep a budget spreadsheet that I reference every once in a while). I’ll have to figure out how I can use this in Mint to see if I am keeping on track there.  If you figure out how to do that Sharon I would love to hear about it.

        • Lori, that’s fabulous!  Congratulations!  I don’t use Mint.com enough to figure out how to adapt it.  Is there any way of doing a second (or shadow) account allocation?  It might get a little messy if an expense is split into two of the three categories.  What if you just commit to redoing what you just did every six months to be sure you’re still on target?  Or every three months if you’re super ambitious?  That would certainly be frequently enough to see if you’re straying, especially as conscientious as you are.  Meanwhile, celebrate your achievement!

  • I’m looking forward to figuring out how close or far off I am from these percentages.

  • Great article, Sharon!  I appreciate you sharing about this practical plan for managing finances well.  

    • Thanks, Pamela.  Hopefully it’s useful to you or to someone you love!

  • I so needed this right now, Sharon.  Thank you for making it simple!

    • “I aim to please,” Victoria.  No, seriously, I know that my greatest chance of getting women to follow through with taking total charge of their finances is to remove all unnecessary complications without losing the essence …

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