A Wealth Advisory Practice

Introduction to Proportional Budgeting

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financial planning budgeting

When we look at developing a financial plan or investment strategy, we are interested in determining a household’s savings and spending profile. This in turn helps us generate a cash flow profile which along with current savings is one of the major cornerstones of developing client investment strategies.

We find however that client’s often need some help with determining their budgets and more importantly – how to structure a budget. We recommend a proportional budgeting strategy. A proportional budget is simply taking percentages of your after-tax income and applying it to 3 buckets: needs/core; wants/flex; savings/proactive. While each household has different circumstances, a great place to start is the 50/30/20 as popularized by Senator Elizabeth Warren.

50/30/20

There isn’t anything magical about the 50/30/20 but rather it strikes a reasonable balance between current lifestyle and the ability to maintain that lifestyle during retirement. For families starting savings later, the percentages would likely need to be shifted more to savings. Regardless, each household circumstance is unique so this is a generic starting point.

50%: Core

The 50% reflects your needs. We like to call these the core expenses and are often difficult to avoid.

Budget items could include:

  • Rent and/or mortgage
  • Utilities
  • Groceries
  • Automotive

30%: Flex

The flex portion of your budget reflects your wants. These are items that reflect more of a lifestlye decision than covering basic needs like gas or electricity. The truth is that there is some blur between your core and flex spending. For instance determining the difference between a house size that is needed versus wanted.

Budget items could include:

  • Dining out (versus groceries)
  • Hobbies
  • Entertainment

20%: Savings

Saving reflects for the most part retirement savings. However – we believe that being proactive with savings should also cover larger expenses that aren’t incurred every year. In the business world these would be considered capital expenditures versus expenses. These savings would reduce the requirement for additional debt or the depletion of emergency funds.

Budget items could include:

  • Retirement savings (pre-tax is included)
  • IRA contributions
  • Debt reduction
  • Emergency reserves
  • After-tax Savings

The great thing about proportional budgeting is that is provides structure and allows more focus on determining where the money is going. We also think this is a superior way to look at savings versus setting some goal to reach a pre-determined level to retire. The reality is that the spending level for needs and wants will have a very large role in determining the success (or lack thereof) of a long-term financial and/or investment plan.