If you enjoy budgeting (or use a budgeting app), then you can skip most of this section. We’ll touch a little on the decision to accelerate payments on toxic debt (to pay it off faster) toward the end of the post, so be sure to check out that information.
The objective of this post is to help you use the 50/30/20 budget framework to generate some clarity on your finances and savings momentum toward your values-driven goals. The 50/30/20 budget gets its name from the percentage of your after-tax income assigned to a “bucket” for needs, wants, and the future. It may be too simplistic for what you need, but we’ve found that complex budgets are a lot like a trendy crash diet… so inherently difficult and painful that it doesn’t do any good and you end up abandoning it.
For this exercise, we’ll be using the following attachments:
The Household Balance Sheet (time to complete: ~1 hour)
First, you need to know where you stand today. Start your planning process by listing all of your assets (the stuff you own) and liabilities (the stuff you owe). From there, look over the past 3-6 months of your bank statements to determine all of the money that’s coming into the household (salary, rental income, dividends, etc.) and leaving the household. All you’re really doing at this point is gathering data on how you spend so you can categorize your monthly spending based on the 50/30/20 framework. We’ve included some categories within the Excel file, so feel free to use or modify those as you see fit.
The exercise of seeing how much you bring in and how much you spend is hugely beneficial from a behavioral modification standpoint. Just like you developed values-driven goals in the first blog post, your spending should be prioritized based on what’s important to you. You may have read books or heard financial experts that emphasize very stringent spending control — and that may be just what you need to get your finances under control. However, we don’t really like the one-size-fits-all spending solution (again, because it’s a lot like a crash diet). And like it or not, you’re going to have to spend money until you shuffle off this mortal coil… so you should spend it in such a fashion that it brings the most value to your life. You’ve already created goals that are really purposeful in this regard; now you need to look at your spending through the same lens. It can be quite eye-opening when you discover that you’re spending way more than you thought on credit card interest, subscriptions you don’t use, or other things that just don’t add value based on who you are and what’s important to you.
Determining Your Emergency Fund (~20 minutes)
Emergency fund needs are driven by a few variables, so simply saying “save 3-6 months’ worth of expenses” may not be sufficient. While you’ll need to cover your basic living expenses and ongoing liabilities, you may also have additional expenses (like medical bills) that could skew the conventional wisdom of 3-6 months’ of expenses. To get started, you’ll need to determine the absolute essential expenses that you’ll need to cover if you were to lose an income source (like a job). Then, assess if your spouse (if applicable) could earn more by taking on additional hours or jobs on the side. We’re planning for the worst case here, but not quite the dystopian future where the robots have become aware. Finally, determine the time required before you could feasibly find another job with similar pay and benefits. If you’re in a highly specialized career field that could potentially require relocation, then factor in that cost as well. You can see that single income families in which the primary earner is in a highly specialized career field may require more in the emergency savings account.
Tackling Toxic Debt (~30-45 minutes)
When it comes to debt, there is good debt, bad debt, and toxic debt. Examples of good debt are typically appreciating assets such as a mortgage and education debt (there are always exceptions). Bad debt is broadly defined as debt on depreciating assets such as a car, boat, or RV. Toxic debt normally shows up as credit card balances, retail account credit (store credit cards), and personal lines of credit or loans. While one-size-doesn’t-fit-all when it comes to debt payoff, the conventional wisdom is to avoid toxic debt and repay it as quickly as possible. For our military audience who have access to career starter loans, we don’t normally classify those as toxic… as long as they are used correctly.
There are a bunch of different ways to tackle your debt, but an easy approach involves starting with the highest interest rate toxic debt, paying it down as your cash flow and budget allow, and then moving to the next highest interest rate in the category. Once you start getting into the bad and good debt categories, there are some trade-offs based on your particular cash flow needs, expected rates of return, current interest rates, and a few other variables.
Putting it all together
We’ve made a short video that uses our hypothetical monthly cash flow sheet to build out a 50/30/20 budget. Please take a look and follow along… and feel free to ask any questions!
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