Clean Your Financial Closet: Spending and Saving
Cleaning closets is not my favorite activity.
However, the result is wonderful. I find clothes that I forgot I owned, I get rid of clothes I don’t want (donating them makes me feel even better), and it’s easier to get ready each morning. A clean closet brings a smile each time I open the door.
Most of all, I get a sense of “Zen”. Everything is organized. In its place. A little oasis of calm.
Wouldn’t it be nice to have the same feeling with your financial situation? A clean financial closet?
The best place to start is with your spending and saving.
Clean Up Your Spending & Saving
Start by keeping track of where your after-tax income goes. That’s your salary, reduced by the amount withheld for federal taxes, state taxes, and payroll taxes. (Be careful, after-tax income is not the net amount in your paycheck, because there are probably other deductions, such as health insurance, or 401(k) contributions. We’ll account for those in a bit.)
There are many ways to do this—financial software programs such as Quicken or Mint, spreadsheets, or even old-fashioned paper and pen. Go through your last several months, then compare your results against my budget guideline:
The 50/20/30 Rule
50% of after-tax income should be spent on Needs
20% of after-tax income should be spent on Savings & Debt Reduction
30% of after-tax income should be spent on Wants
Now I realize everybody’s income and lifestyle situation is different, but nonetheless, this breakdown is a good check on where the money is going! Here’s a little more about each category…
Needs (50%)
These are your essentials. There is not much you can do to change what you spend here, unless you are willing to make major lifestyle changes—a less expensive house or apartment or, a cheaper car, for example. Needs include:
- Groceries
- Housing (mortgage or rent, real estate taxes, homeowners insurance, repairs etc.)
- Basic utilities, phone, internet
- Health insurance
- Medical expenses
- Other insurance: life, disability, auto, etc.
- Transportation (car payment, gas, repairs, public transportation, Uber, etc.)
- Minimum loan payments
- Childcare and other expenses that allow you to work
- Alimony, maintenance, child support
Savings & Debt Reduction (20%)
Start by saving in your retirement plan at work— at least enough to get any available “match” from your employer. Your next allocation within this category should go towards:
- Building a three-to-six month reserve of monthly “Needs” spending (a rainy day fund)
- Paying off any credit card balances.
Once you’ve done that, next up is saving for:
- Large purchases
- College tuition (open 529 plans— very effective)
- Retirement (IRAs, Roth IRAs, investment accounts)
Wants (30%)
This is the fun stuff! These are discretionary items, and you have more flexibility here. Wants include:
- Dining out / entertainment
- Gym memberships, etc.
- Travel
- Luxury purchases
- Hobbies and collecting
Some questions as you finish cleaning your financial closet … Do your spending decisions line up with the 50/20/30 guidelines? Any surprises? What changes in your spending do you plan to make?
Happy Cleaning!
Shari Greco Reiches