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Financial Planning 101: Paying Yourself First and Other Budgeting Tips

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November 30, 2016
School Books with Apple: Financial Planning 101

We’re often told to put others first: Take care of mom and dad. Give to charity. Save for college. Hand someone else the life jacket as the Titanic goes down.

But from a budgeting perspective, it actually pays to be a bit selfish. After all, it’s hard to help someone else if you’re feeling destitute.

Many financial analysts advise investors to “pay themselves first.” That means setting aside 50% of the budget for daily living and 20% for retirement savings and paying down debt. The rest can be put to “personal” use, meaning vacations, visits to the coffee shop and other fun pursuits. And, to the surprise of many young people, cell phone and cable plans fall into the “personal” bucket.

Notice there’s nothing in this so-called “50-20-30” plan that talks specifically about college savings or taking care of elderly parents. With a “pay yourself first” philosophy that includes responsible budgeting, investors can better prepare for other eventualities down the road. That doesn’t mean not to save for big-ticket items like education or elderly care; it just means budgeting for expenses to reach the point where one can help parents and children without sacrificing one’s own goals.

“At the end of the day, you have to look at the big picture,” said Robert Siuty, Senior Financial Consultant, TD Ameritrade. “What are your goals, what are you seeking to accomplish, and how do you get there? Expenses play a big part in this.”

Make a Budget Plan and Write it Down

Siuty encourages investors write down a plan, whether it’s an electronic spreadsheet or an old fashioned pen on paper, because investors who plan their budgeting have a much better chance of sticking to it.

“It all comes down to having a plan and sticking to the plan and being disciplined,” Siuty said. 

Investors should consider the expenses they’re almost certain to have, including food, gasoline, home and property taxes, utilities, health insurance, and mortgage payments, Siuty advised. These expenses form the first bucket of the budget, the “50%” that can’t be avoided.

The second tier of the budget, or 20%, can be devoted to retirement, debt payments (including those pesky interest payments on the debt), building an emergency fund, or other big-ticket items like a new home, a dream vacation, or a sailboat. The idea is that down the road, this money can accumulate and also be used for those other important people in life, including parents and children. Consider this the “goal” bucket. 

While a goal like finishing payments on college debt may not be as “fun” as counting down the months until a dream vacation, it can be useful to put on paper all the remaining debt payments, how long until they’re out of the way, and how much they cost each month. The results can be eye opening. And finishing the payments might be almost as exciting as leaving for a Caribbean beach!

Through careful planning, some of the money going into the second bucket can be automated, either through cash sweeps in which cash in the bank automatically gets transferred into interest-bearing accounts; 401 (k) contributions, or “robo” investing programs offered by brokerage firms including TD Ameritrade. Automation can make it easier to start an emergency fund and to keep contributing to it, because the money is put aside before it can be spent. Those just starting out know how difficult it can be to get a foothold, so it’s worth considering automatic set-asides like these to get on track early on.

The third tier of expenses, or the “30%,” can be allocated toward things one likes to do, but within the realm of budget reason. For instance, instead of owning season tickets, perhaps buy tickets to just a handful of games. Vacations and vehicles come under the same heading, but those who budget most successfully also vacation responsibly. Perhaps they take a camping trip instead of a cruise. Or they buy a car that’s good enough rather than splurging on the most desirable convertible at the dealer. Remember the fewer the expenses in this category, the more progress you can make in savings goals.

To fully understand what goes into each bucket, try tracking your expenses (yes, every single expense) for the next 30 days. This can be illuminating, showing where savings are possible and where too much is spent. For instance, are all those subscriptions really needed? How about restaurant meals? Studies show that young people spend more on retail purchases and on eating out than older generations. Are you guilty? A restaurant treat can certainly be part of a responsible budget, but if it’s an every-night event, it may be time to consider polishing up those cooking skills (and cooking can be fun, too!).

Paying Yourself First

All this may sound great on paper. Who wouldn’t want to buy a boat or a new house? But where does the money come from? The most successful investors tend to see savings as its own budget item, and regularly put money aside for future considerations.

“Many people who accumulate a lot in a 401 (k) plan know every time they get paid, there’s a direct percentage coming out that’s a forced savings,” Siuty said. “They don’t see it. They budget around their net income. Some see savings as a line item. They make saving like an expense. Just like paying a utility or mortgage expense. They make it a forced line item so no matter what, that money goes into reserve for savings.”

It’s not necessarily going to be easy, and it’s best to start early. The benefits tend to become more obvious as time goes by.

“There are three different phases in life,” Siuty said. “The first stage is when you’re starting out, with nothing accumulated. During the second stage, your money is in the market, working for you and making more money. By the third stage, those dollars are like running your own business. Think of those dollars like your employees working for you and producing for you with the goal of maintaining the lifestyle you want in retirement.”

If investing to pursue your goals is something you’d like to learn more about, visit the New to Investing page which will help you get started.

Hands-On Goal Planning

Planning for tomorrow involves setting financial goals today. Are your plans on track?