For me, learning how to navigate finances has been a 20 year process. My parents told me to build good credit and not to go in to debt for anything but a home, car, and education. I'm forever grateful they set me off on the right foot to do just that. They paid for my undergrad and built good credit for me by cosigning on a car loan they paid for monthly (so yes, I acknowledge I had a lot of financial privilege as a young adult). But when I look back, I realize my parents taught me the what about finances without really teaching me how. I didn't know how to budget.
Before any purchase, I always knew I had to have enough money to make the purchase and enough money to pay any bills that would come up before my next paycheck. This is a fine way to live paycheck to paycheck, but it is not budgeting. Sure, I was using free online budgeting tools to track my spending, but what I should have been doing was tracking my money to determine my spending. See the difference? I was living in a spend what you make and then figure out how it fits in your budget cycle instead of a track what you earn and budget how you are going to spend cycle.
I wonder how many other young adults (and even grown adults) function this way? I'd imagine it's quite a lot. According to research most of us to spend just 5 to 10 percent more than we earn. So we aren't that far off on our budgets, but over time this habit leads to credit card debt -- which is exactly what my parents taught me to avoid. It's great advice, but without a how to map, it's hard advice to follow.
With the help of some very basic financial tips from people like Dave Ramsey and Elizabeth Warren, and places like NPR's LifeKit podcast and You Need A Budget columns, I have honed a system over the last several years that really works well for my family. I found my how to map, and I thought I'd share it here in case any parts of my budgeting process would work well for others.
START WITH A ZERO SUM BUDGET
One of the first big changes I made was to pay for an online budgeting tool. Three years ago I signed up for YNAB and I have absolutely no regrets. The free online budgeting tools I'd been using just weren't serving me well. If you need visual proof for how much YNAB helped turn our finances around, take a look at this:
Between home improvement projects, vehicle loans, and living that 5-10% above our monthly income, we'd accumulated almost $26,000 of debt. Yikes! The thing I love most about this image is that climb from 4/20 to 4/21. Between the pandemic and some marriage troubles, that was a really terrible year, but somehow we climbed our way out of debt.
Let's quick talk about some bumps and flatlines you may notice on that graph. You can see the first five months were pretty steady. It's typical for people to take a few months to get a sense of what they are spending and what they can do to earn more and cut costs. I'm glad I didn't give up after not seeing much change for the first four months.
You likely notice some big jumps at the beginning of each new year. Those are our tax returns. I prefer to receive our child tax credit on a monthly basis. If you do too, check out Senator Romney's Family Security Act, and if you support it too, call your legislators and tell them to sign on.
The first dip (4/20) was the purchase of a new car. That set us back, but we had it paid off in just two years. That's something we never could have done in the past. The other dips (8/21 and 1/22) were my tuition payments. In addition to paying off a car in two years, I've been able to go back to school for a master's degree without taking out any student loans (yet). That's another thing I would have never thought was possible three years ago. So let's get down to the details of how all this was possible.
THE 50/30/20 PLAN
Here's where I used a combination of Dave Ramsey and Elizabeth Warren (quite the pair, I know). I like Dave Ramsey's debt snowball idea and I've always been committed to paying 10% of my income to tithing. So those were two ideas I could follow with perfection. I did not buy wholesale into some of his other, more restrictive, ideas. That's where I adopted Elizabeth Warren's 60/20/20 approach. Warren suggests people use 60% of their income for necessary living expenses, 20% for paying down debt and/or saving to avoid debt and plan for retirement, and 20% for life's pleasures. A lot of other advice I'd read confirmed this idea. Savvy savers pay themselves 20% (for savings and investments) first. Other financial experts warn against depriving yourself of nonessential things like occasionally eating out or taking a vacation in order to pay off debt and save for retirement (the Ramsey approach). Too much restraint can lead to unrestrained splurges.
For the first couple years I put 60% of all our income into our living expenses and tithing. I then put 20% right into tackling our debt, using the Ramsey snowball method. Finally, I did my best to keep 20% available for things like a YMCA membership (until I wised up and got a job there and had a free membership), family vacations, and other fun but not completely necessary things. Occasionally I did dip in to that 20% to cover an unexpected necessary expense (darn car repairs) or to increase debt payments and save on interest.
I've made a few adjustments over the years and feel really confident that I am at the perfect place now. My first adjustment was to move our 10% for tithing out of the necessary bills category and into the savings category. It's a small change, but an important mental switch. So now we have a 50/30/20 plan. Half of all our income goes right into the following eight categories: mortgage, groceries, vehicles (repairs, fuel, registration), utility bills (phone, electric, internet), home maintenance, medical bills, clothing, and personal care (toiletries, haircuts, etc).
Categories like the mortgage and utilities always have a set amount and are fully spent by the end of each month. Other categories, like vehicles, home maintenance, and medical, may fluctuate to cover (and ideally save) for those unexpected expense. Other categories, like clothing, may have $100 set aside each month without spending any for several months until all my kids suddenly new need shoes. If our income goes up one month, I can put a little extra in categories that might need a bigger cushion. This is how we save up for emergency expenses and stay two to three months ahead of our bills.
But we still try to build up savings elsewhere, which leads us right into the 30%.
Like I said earlier, so far I've been able to pay for graduate school without taking out any student loans. It feels fabulous. I consider furthering my education an investment, so this expense goes right alongside saving for an emergency fund, investing, and charitable giving. Remember, this portion of our budget used to be 20% to snowball debt, but after about 15 months of doing that, we were debt free and able to switch it over to a savings and investment category (just like Elizabeth Warren recommended). My goal is that if we need a car loan in the future (I'm guessing we will, sorry Dave Ramsey) we'll put that expense into the vehicle category and we'll be able avoid ever using 20% of our income for debt payments.
Finally, we put the last 20% in what YNAB calls "Quality of Life Goals." As much as I'd love to pay off my mortgage in my 40s, I prefer to take a family vacation once a year, let my kids take music and sports lessons, and have a decent Christmas. We don't live frivolously -- most our family vacations have been spent in state parks and we do not have the money for traveling sports teams or a dog (yes, our family pet really is a turtle).
One of my favorite things about this system is that we can put some money each month into things like a vacation or gifts and build up a decent amount for a couple nights in Chicago or a memorable Christmas. I'm no longer suddenly approaching the holidays and wondering if I have enough for all the gifts I need to buy. I know exactly how much money I can spend and that is what determines the gifts I buy.
Final Thoughts
I may come back in a few years and realize there is an even better system for our family. I personally recommend everyone do what I did, and just read as much as you can from different sources and find what works best for you. I have friends who love Dave Ramsey's approach and others who likely need to spend more than 50% of their income on necessary bills. Make the adjustments that work for you.
I expect this to always work for us though. As I return to work in a few years and our income goes up, every category can go up. That means we can update our vehicles, take nicer vacations, save more for retirement and give more to charity. As long as I know we are living within our budget and have a couple months worth of savings built up in each category, we can handle small lifestyle creeps and unexpected expenses as our salaries increase.
