Two Methods on How to Budget and Build Wealth
New Zealand
Personal finance can be emotional, and many financial decisions are based on these emotions. Some people spend more money on their homes because that is what makes them the happiest. Others spend money more money on travel because they are happiest when they do so. Some experts will say to take the emotion from the personal finance journey, but I think instead, you should use this emotion to guide your journey. I was stressed and anxious when I was in medical school and piling on six-figure debt. I was delighted the day that my wife and I paid off our large six-figure student debt. I use those memories to continue saving, investing, and teaching others to do the same. I don't want to feel stressed and anxious about money again. Hone in your emotions and figure out how you want to feel and what is most important. Like all things in life, you need a plan or process to reach your goals. In this post, I will be discussing a couple of different methods to approach saving and investing.
The first method I will discuss is the 50/30/20 rule, made famous by Elizabeth Warren in her book "All Your Worth." The idea is that 50 percent of your after-tax spending should go needs. These needs will include shelter, clothes, groceries, childcare, and essential bills like water or light. Thirty percent will go towards wants which could be anything that you don't need. You will hone on your emotions and spend money on things that bring you joy and keep you continuing to budget and avoid burnout. Lastly, 20 percent will go towards savings, investing, and paying off debt. Examples of this will be creating an emergency fund, paying off credit card debt, and investing in a 401k.
To follow the 50/30/20 rule, you must first understand where you are spending your money. This can be accomplished by reviewing your credit or debit card statements over the last three to six months. If these do not give enough information, you can track the next two months of spending using an app such as mint.com or manually keeping a record. This information will establish a baseline for your current percentages and the adjustments that need to be made to reach your 50/30/20 allocation. By following this method, you will start to see incredible progress made in your financial journey. Give yourself at least a year before choosing to increase the percentage spent on savings, debt, and investing because the key is long-term success and avoiding abandoning the process altogether.
The second method is the idea of paying yourself first. This method focuses on the needs and savings/investing/debt percentage, and the money spent on wants is a by-product of these two. You calculate first how much money you will need to pay all your essential bills. Then, you determine what percentage you will allocate for investing. Lastly, the remaining money left after paying all your bills and investing will go towards things you want. To assure success to this method, make sure that the percentage of investing/savings begins around 20-25 percent.
The keys to this method are simplification and automation. You minimize day-to-day financial decisions that could cause you to abandon your process. All your bills and debts are paid using autopay. You are investing in your companies' 401K plan pretax before you even see it, and it is the same amount each pay period. You are auto-investing with your financial institution of choice on payday and never seeing it in your bank account. This method takes the guilt out of spending money in your bank account because you have already paid your bills and invested that month. Another benefit of this method is that it removes the temptation to spend money on things you want because you never see the money in your account.
In summary, regardless of which method you choose, the key themes are to make sure that you are paying off debt, saving money, and investing every month. Always have money for things you want because this will keep you from burnout and abandoning your path towards financial independence. Use emotions in personal finance as a strength, make small changes in the right direction to your process, and don't give up.
