Financial Life After Yale – Your Budget
Why your budget matters. Some Yalies don’t budget when they leave campus. That’s risky. Unless you start your careers in severe thrift mode – or unless you’re getting paid potloads – you’ll want to track your money flows. In this post, I’ll discuss:
- Why your budget matters
- Your budget’s 5 moving parts
- The 4 horsemen of taxes
- Sacred savings
- Tracking transactions
Why your budget matters. Budgeting isn’t supposed to be punishment. Your budget won’t be a dark cloud over your head. Creating a budget can help you in many ways. A good budget:
- Categorizes your expenses
- Highlights how to change your spending behavior
- Points the way to savings opportunities
- Makes it easy to compare your intended plans to what actually happens
- Gives you a template for future budget refinements
- Fits into your longer-term money plans
Your budget’s 5 moving parts. Your budget’s architecture can be fairly straightforward, with 5 moving parts:
- What you bring in (early on, most of this will be income from your job or jobs)
- Your tax payments (more on this below)
- Your savings goal (ditto)
- What you need to spend (i.e., non-discretionary spending)
- What you want to spend (i.e., discretionary/aspirational spending)
Non-discretionary spending might include, for example, rent or home-ownership costs, basic work/leisure apparel, groceries, medical insurance or out-of-pocket expenses, and commuting costs. Note that these are labeled “non-discretionary” rather than “fixed.” That is because – over time – you can creatively change almost any type of spending. For example, rent expense might seem to be a fixed spending item. But, over time, you could decide to add a roommate, or move to a less-expensive neighborhood.
Discretionary spending might include, for example, entertainment, eating out, vacations and gifts.
To these 5 budgetary moving parts, as you become more comfortable with the process you may decide to create a 6th: items that will last for a very long time (e.g., durables). Examples might include buying a car, or making a downpayment on the purchase of a house.
You can find a start-of-career hypothetical budget here: Sample Budget
The 4 horsemen of taxes. Most of us working in the US will pay at least four kinds of taxes: Federal (i.e., to the IRS), state, Social Security and Medicare. The first two of these (Federal and state taxes) result from complex tax tables and other considerations. Early in your career, when your earnings are modest, if you’re working full-time as a “W-2” employee the latter two (i.e., Social Security and Medicare) will usually consume between 7.5% and 8% of your pay.
Thanks to the complexity of Federal and state taxes, budgeting for the 4 horsemen of taxes isn’t straightforward. Examples may be helpful. If you’re a W-2 employee currently earning about $50,000 annually, it would be unsurprising for you to owe taxes (all 4 types, combined) equal to between 20% and 25% of your pay. If, instead, you were currently earning about $100,000 annually, it would be unsurprising for taxes to consume between 25% and 30% of your pay. Of course, how and where you live, and how you choose to spend in certain areas (e.g., charitable gifts, education, business expenses) can dramatically alter these percentages, and place them outside the ranges above.
One thing about taxes is certain: unlike your discretionary and non-discretionary spending, taxes are a legal obligation.
Sacred savings. When you create your budget – when any of us does so – it’s perfectly natural to take what you earn and subtract taxes, and then subtract what you need to spend, and finally to subtract what you want to spend. Is anything left? That’s what you’ll (try to) save. This sort of budget logic may seem natural, but it’s also insidious: the savings amount that you set aside in your budget is merely what’s left over. That’s not a disciplined way to envision something as important as your savings.
Instead of that type of logic, try to flip things around. Set yourself an annual savings goal. Express that goal as a percentage of what you expect to earn annually. As you create your budget, subtract your expected taxes and your savings goal from your expected earnings. Then: allocate what’s left in your budget among your non-discretionary and discretionary spending categories.
In essence, you’ll be acknowledging – for your own good – that it’s better to spend what you don’t save, and not vice-versa.
So: is there rules of thumb on how much you should save? Indeed there are. For example, a commonly-discussed longer-term goal would be to save you’re your retirement) between 10% and 15% of what you earn. Two comments about this: (i) these percentages are meant to track your gross pay, not your take-home pay; and (ii) there will be many years (especially early in your career) when saving such a large percentage of your earnings may seem impossible. Don’t let this get in the way: goals like this (10%-15%) apply to the longer term. For example, perhaps you should think it terms of how much you save during rolling 5-year time periods.
Tracking transactions. Budgeting software and apps are easily available, and are either free or cost so little that they’re worth the price. Good budgeting packages will allow you to categorize your spending, create easy-to-read reports, approximate your taxes, and tie into your longer-term money plans. Two of the best-known are Quicken (www.quicken.com ) and Mint (www.mint.com ).
Stay tuned! In later posts, I’ll cover:
- Longer term money needs
- Things we can control…and things we can’t
- How we can be money-disciplined
- Rules of thumb for our spending, investing and retirement
- How to establish – and improve – our credit