How to budget money on low income

One of the simplest and most impactful ways to secure your family’s finances is to build and follow a simple budget plan.  On the surface, it sounds really easy.  Just follow the plan and everything will take care of itself right?  The reality is that life tends to get in the way of budgeting, and people begin to lose track of where their money is going each month.  They lose track of how many latte’s they get a week, their monthly subscriptions, what other family members are doing, or even how much they pay for basic utilities.  Sticking to a budget can be a game changer for some people, especially those that make a good income, but still can’t seem to get ahead. 

The 50/25/25 budget plan

One of the most popular budgeting plans is the 50/30/20 plan.  This means that 50% of your after-tax income should go towards necessities, 30% towards “wants” and 20% towards debt and saving for retirement.  The idea is that if someone follows this plan, and more importantly sticks to this plan over their lifetime, they will get out of debt, be able to retire comfortably, and most importantly still have room for fun and some indulgence.  While we like this plan at Arrow, we prefer a 50/25/25 plan.  There is still plenty of room for “fun” in 25% of your income and allocating a little extra towards retirement and paying off debit is definitely preferable over the long run.

Separating needs from wants

This is where keeping and sticking to a budget gets tricky.  The boundary between needs and wants is blurry, and it varies by family.  Your needs should definitely include the following:

•         Groceries

•       Utilities

•         Insurance

•         Housing

•         Transportation

•        Childcare and work expenses (work clothes etc)

 If your needs are greater than 50% of your take-home income, then you should consider dipping into the “wants” section of your budget until you can reduce costs below 50%.  Perhaps get a cheaper car payment, refinance your mortgage, switch to liability insurance, or rely on family instead of a childcare service.  The reality is that following a budget doesn’t magically make your financial situation better.  If you’re living paycheck to paycheck and simply can’t afford your basic needs, no amount of budgeting will solve that problem.

 Wants are bit more difficult.  Generally, all of the following should be classified as wants:

•       Travel and vacations

•        Entertainment (TV, Netflix, movies, amusement parks, bars etc.)

•      Gifts

•        Dinners out, food that goes beyond necessity (work lunches, organic food etc.)

•        Hobbies, collectibles, house decor etc.

 Things tend to get difficult in the wants category because many things that people view as necessary really aren’t.  While it’s certainly nice to have fancy work clothes, many people could probably get away with cheaper options.  Other things like gym memberships and vehicles tend to be debatable.  You might *need* a car to get to work, but an older high mileage car might work just fine, and would save you a lot of money.

 At Arrow, we feel that it’s important for people to have fun with their money.  Saving for retirement and sticking to a budget is going to be impossible if the journey to the end goal is unbearable.  We want our clients to be able to spend time with their family, go on fun vacations, and enjoy their life so that they are better able to become debt free and plan for retirement.

 Is allocating 25% towards debt repayment and retirement saving too much?

 We don’t think so, particularly if you want to retire before 65.  In our 10 tips to retire by 55 article, we outlined the optimum order to contribute to your retirement accounts and to pay off debt.  If you allocate a high percentage towards debt repayment and retirement early in your life, the effects are compounded, and in the end, you might not need to stick to 50/25/25 later in life.  In other words, a large investment early might mean much more discretionary fun-money later down the road.  You can use some flexibility in this category, especially for unforeseen life events, emergencies, or unexpected expenses.  But many people use that as an excuse to allocate less to saving, so it’s important those deviations from the plan are only temporary!  The easiest way to stay on track here is to automate the process, preferably with a low-cost fiduciary.

 How do I keep track of all of this?

 We use financial planning software to automate the process for our clients.  In other words, we automatically calculate how much they put into the different categories by syncing their bank and investment accounts and tracking their cash flow.  For a simpler version of this you could use a MS Excel template, or apps such as Personal Capital, Mint, or YNAB.  Most of these apps track your progress and allow you to revisit your budget over time.