Budgeting: Using Income Allocation
I have only four categories in my monthly budget. You could as easily get away with using just two of these. I often see bloggers breaking down their monthly expenses into 101 different categories, and that works for some people, but I don’t have the time or the inclination to monitor every penny I spend each day.
For me the four categories are: Spending, Saving, Accommodation, and what I call Welfare. You could just as easily combine Spending and Accommodation and have just two categories: Spending and Saving.
My current monthly budget or allocation of my net income looks something like this:
35% Saving
30% Spending
25% Accommodation
10% Welfare
Below I explain in a bit more detail what each of these items are. Some are straight-forward, others will need further posts to expand on them fully.
Saving (35%)
This is the proportion of net income I put towards long term savings. I will go into more details on some of the investment vehicles I use in later posts. For now, especially if you are just starting off, it’s wise to keep this in cash preferably in an easy access savings account that pays some interest (admittedly it will be low in this day and age, here in the UK your should be able to get over 1% still).
With the saving proportion of your budget you want it to be as high as possible. When I first began my journey to financial independence my saving rate was 15%. Over the years I have increased it. In 2015 it was at 25% and I upped it to the current level of 35% in 2016. My target is to get this to 40% in the near future.
Spending (30%)
Again fairly self explanatory this is simply your spending budget each month. You want this to be as low as possible but at the same time obtainable with some room for unexpected or one off items. I find 30% of my net income to be comfortable. I probably spend around 20-25% most months so that there is some excess for big ticket items such as holidays and flights, etc. Again don’t be afraid to start fairly high with this one. In 2015 my spending budget was 35% and at the beginning above 50%. As long as you are able to stick to it is all that matters to begin with. As you become more frugal or your income increases you can lower the level.
Accommodation (25%)
You could combine this with spending but I prefer to keep the two separate. It also helps when you are moving to know what your monthly budget is and prevent you from spending too much on rent or over stretching yourself when buying a home. A long time ago I read Donald Trump’s book Think like a Billionaire where one of the things he states is that people should not spend more than 25% of their income on accommodation. These days it’s quite difficult to achieve but I agree that the basic advice is sound.
You may have noticed that I think that this budget does not only apply to renters. Homeowners should also budget for accommodation. If you are a homeowner you should think of your home as being owned by your savings fund and you are merely the tenant. In this way you pay rent to your savings fund and your savings fund can then pay the mortgage. If you are mortgage free then the rent you charge yourself will still be added to the savings fund. So if I owned my home without a mortgage I would pay both my accommodation budget and savings budget into my savings fund which in this case would be 60% (Savings 35% plus Accommodation 25%). You might think it’s strange to do it this way but the logic behind it comes from Robert Kiyosaki’s Rich Dad series which refuses to count your home as an asset. By paying yourself rent on your home your home is no longer a non-performing asset. I will return to this topic in a later post as it can get quite complex.
Welfare (10%)
This is a fairly new addition and one that raises a few questions. I originally got the idea for this from Tony Robbins in the Power of Tithing as a way of living an abundant life. Tithing means giving away 10% of your income with the idea that if you can live without that 10% then you will never be truly poor. For those that believe in the law of attraction the idea of giving away 10% of your income might also sound reasonable as the good-will of the action would help to bring further abundance into your own life. For me I see the positives of this and it has been part of my budget since the beginning of 2012.
So what exactly is it? Well strictly speaking it would mean giving 10% of your income each month to a charity or the poor or more traditionally the church. I use the money for a range of purposes that I consider virtuous. These include charitable donations, gifts for others, rewards and incentives to motivate myself, etc. The 10% doesn’t need to be spent fully each month and I keep a separate account to keep track of the balance which currently stands at over £3,000. Again this is a fairly complex fund and I will post more details on what exactly it is and how I run it later.
So there you have it. The four categories that I use to help keep myself on track. In the beginning your allocations will of course be different from mine. Over time it’s a good idea to try to reduce the Spending and Accommodation budgets and in turn increase the Savings budget. The Welfare budget is something you might like to give a go and I will post soon further details of what it includes and how you can adapt it to suit your needs.