At HTG, we discuss with our clients the importance of creating good saving habits – start early, save as much as you can, but leave room to have a little fun in your life. A common question we receive is “Where do I start?” Developing a spending plan is a great first step toward establishing good saving habits.
What is a spending plan?
In my day, we called it a budget. I guess spending plan sounds more favorable. In short, a spending plan (budget) is a plan for every dollar of income you make. It must cover all your needs (rent, groceries, car payment), some of your wants (dining out, a vacation), but most importantly, savings for emergencies and the future (emergency fund, retirement plans). An annual plan is ok, but I prefer breaking down my income and expenses monthly. It’s more work, but I appreciate knowing how much I am spending each month and where my hard-earned income is being spent. More importantly, a spending plan allows me to better understand how much I can save each month. Or, in some cases, it points out where I’m overspending and need to cut back to allow me to save more.
How to start a spending plan?
I recently had the opportunity to work with one of my sons to help him develop his own spending plan as he has graduated, started a new job, and migrated off the “Donaldson Family Payroll”. We followed these few easy tips to get started.
- Calculate your monthly income. If you receive a regular paycheck, start with the amount deposited into your checking account each month (i.e., your income after taxes and deductions). If you have automatic deductions each pay period – 401(k), health savings plan, health insurance – be sure to add those back as savings in your spending plan to get a better picture of your true income and expenditures. Don’t forget to include other forms of income (net of taxes) that might come from side jobs.
- What are your monthly living expenses? Write down all your living expenses – rent, groceries, shopping (clothes), utilities – the more detailed, the better. I have provided a list of living expenses here to help get you started. If you do not know your monthly expenses, track them for a few months to provide a framework to use going forward. Don’t forget to include any form of debt repayment as a living expense (i.e., student debt, credit card debt, car loan).
- How much should you save? Hopefully, when you deduct your monthly expenses from your income, there is something left over. That’s your starting point for how much to save. Traditional savings options include emergency funds, 401(k) plans, IRAs, Roth IRAs, or health savings plans. We recommend that you start with building an emergency fund – six months of living expenses is a good target. As soon as possible, contribute to your company’s 401(k) plan as many firms still match some level of employee contribution. Next, aim to pay down higher-interest loans, such as credit cards. If you have extra money to invest, a Roth IRA is an incredible savings tool. 2023 Roth IRA contribution limits are $6,500 for individuals under age 50 and $7,500 for individuals age 50 and older (subject to income levels).
In the event you have nothing left over after expenses, or you feel you should be saving more, then the hard decision of where to cut back will have to be evaluated. Some suggest that as much as 20% of your net income should be used for debt repayment and savings. For some, that might be difficult, but early on, it’s important to save something each month. The fact is, putting money away at an early age is one of the BEST decisions young adults can make. The immediate satisfaction will be limited, but the long-term benefits will be quite substantial.
- Choose a budgeting app. There are a variety of budgeting apps online, at little-to-no cost, that can simplify the budgeting process, such as Mint, YNAB or PocketGuard. When choosing an app, make sure to select one that will sync to all your important accounts – checking, savings, credit cards, auto loan, student loan, and retirement accounts – as this will save you valuable time recording all your spending transactions. For those willing to roll up their sleeves, an Excel spreadsheet will do just fine. It’s a little more time-consuming tracking your transactions each month, but it’s a good way to really get into the details of your spending habits. Set monthly targets for spending by category, prioritizing needs like rent, groceries, and utilities.
- Track your monthly progress. A spending plan is pointless if you do not track your progress. Some apps will notify you as you get close to your monthly limits. Regardless of the app you choose, manage your budget through regular check-ins.
It’s never too late to start saving, but the earlier you start, the bigger the benefits. You might have just graduated from college. You start your first job and suddenly, your bank account has cash placed into it every two weeks. The obvious temptation is to enjoy this new financial windfall. A nice apartment? New car? Dinner out every night? It’s normal to enjoy a little reward for all your hard work. But unfortunately, spending can get out of control very quickly.
A spending plan takes a little effort, but it’s a great way to put you on the path towards responsible spending and saving habits.