Now that you’ve got your Must Haves itemized and your sources of income put together, we’re going to turn to the question of balance. Remember the three buckets I mentioned in “What you can afford, made easy“? They were Must Haves, Savings and Wants, as described in All Your Worth by Elizabeth Warren and Amelia Warren Tyagi.
What is financial balance? It’s a way to allocate your funds to give you the most financial flexibility. It’s making sure one bucket doesn’t take over from the other, so you always have enough to cover your obligations, have fund set aside for the future, and have money left over for fun. By making sure your spending stays within certain proportions, you’ll always know whether or not you can afford something. The formula is:
- Must Haves: 50%
- Savings: 20%
- Wants: 30%
What? Are you telling me to live on half my money and save 20%? Are you nuts?
No. What we are suggesting is that you keep the obligations to which you are legally bound and committed to 50%. Why? Because it gives you financial flexibility. When the ratio creeps up to 60, 70 or 80% (quite possible in today’s lending environment) what happens? You have nothing left over for that new blouse, trip or rainy day.
So let’s take a look at your numbers.
Add up all your monthly sources of income, after tax, but before any other deductions. Keep a separate total of anything that is deducted for retirement savings, or non-registered savings, like a stock savings or deferred profit sharing plan.
Add up all your monthly Must Haves. Divide that total by your monthly Total Income, after tax and before deductions and multiply by 100%. Now you’re got the first ratio for the Financial Balance Formula.
How does it look?
- Below 35% – You’re in great shape. You’ve got lots of flexibility.
- 35 – 50% – You’re in good balance.
- 50 – 65% – You’re getting into dangerous territory, and probably find yourself scrimping on both the fun stuff and savings.
- 65% – Over-committed, big time. Your paycheque is spent before you see it and every unexpected expense probably feels like a catastrophe. Hang in, though. We’ll make some suggestions on how to improve things in upcoming blogs.
Now let’s turn our attention to the other two buckets: Savings & Wants
Savings. This is money you set aside, in a savings or investment account, or some type of retirement fund (through your employer or otherwise). Savings also include debt repayment – the amount by which what you owe goes down. Let’s say your mortgage is for $100,000. Each month your payment includes interest and principal. The principal portion of the payment is the amount by which the outstanding balance shrinks. For the purposes of this calculation, any extra monthly amount you put towards your loans, above and beyond the minimum payment, (which is a Must Have) is savings.
Calculate your monthly savings, including the employer deductions from your paycheques.
Credit cards and lines of credit deserve special mention. If you are carrying a balance on your credit cards or lines of credit, check to see what they were a year ago. If the amount has increased, you are going further into debt, and that amount should be deducted from your savings calculation. If it has decreased, then that amount is savings. Calculate the difference between your current balance and the year ago balance and divide by 12. That amount should be added (balance has decreased) or deducted (balance has increased) from your monthly savings.
Now divide your monthly savings amount by your monthly income figure (after tax, before deductions). Drum roll, please:
- More than 20% – Huge saver – you clearly have no issues in delaying gratification!
- 12 – 20% – Very strong saver – you keep the future clearly in mind
- 5 – 12% – Solid Saver – you’re on the right track
- 0 – 5% – Getting started
- below 0% – Going into the hole – This is a scary place to be. Either Must Haves or Wants are taking too big a portion of your income. Stay tuned! We’ll offer some suggestions in coming weeks.
Wants. This is the easy part. It’s everything else. If it’s not a Must Have and it’s not Savings, it’s a Want. It’s that simple.
How does your 100% add up?