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A Deeper Look at Proportional Budgeting
To people who don’t actively budget, budgeting can seem like a complicated mess involving spreadsheet programs, notebooks, and other materials. To others, it can seem like a restrictive nightmare, keeping your different types of spending in a tight box and holding back your freedom of choice to an unpleasant degree.
(I actually don’t find either to be true, but I’ve certainly heard the complaints.)
One solution to both of these problems is to move to a simpler budgeting system, one that offers only the most basic of spending guidelines and gives you a lot of flexibility within those guidelines. It’s a great solution for people who want to improve their financial situation but don’t like to have each category of their financial life in a tight box.
That’s where proportional budgeting comes in.
What Is Proportional Budgeting
Proportional budgeting means that you simply divide up your monthly income, whatever it may be, into three piles based on percentage. A certain percentage goes to cover your “needs” – your monthly bills, taxes, health care, food, and basic household requirements. Another percentage goes to “wants” – the stuff you buy for personal pleasure. The rest goes to “savings” – the amount you put aside for the future each month.
So, let’s say you earn $3,000 a month before taxes. If you were living with a 50/30/20 budget, that would mean you should be spending $1,500 a month on “needs” – rent, taxes, food, other bills, and so on. You should be spending $900 a month on “wants” – television bills, Netflix, entertainment, and so on. The rest – $600 a month – should be saved in whatever way you choose, such as an emergency fund, a retirement account, a savings plan for a down payment, or whatever else might fit the bill.
One of the biggest challenges of proportional budgeting is distinguishing wants from needs. A “need” is something that, if left unpaid, could lead to legal ramifications and/or severe illness and/or job loss. A “want” is everything else.
It’s a tricky line because of categories like food. Food is a mix of “needs” and “wants.” You absolutely need some food, but you don’t need to eat out and you don’t need many of the expensive options from grocery stores. People are often tempted to slide things they really want and things that they’ve become accustomed to having into the “need” category when, in truth, those things are “wants.”
So, before you even think about proportional budgeting, you need to get your mindset straight when it comes to “needs” and “wants.”
Some Examples of Proportional Budgeting
Here are three examples of proportional budgeting. The first is more of a hypothetical example, but the latter two are mentioned with at least some frequency in personal finance books and on other websites.
60/40/0 – Paycheck to Paycheck Life
This is what the hypothetical “paycheck to paycheck life” looks like. It’s made up of 60% needs, 40% wants, and 0% savings.
This budget is almost a perfect example of the difficulty that comes with distinguishing between “needs” and “wants.” In most paycheck-to-paycheck situations, the people involved have a great deal of difficulty separating the two. $200 at the grocery store is a “need.” A $160 mobile bill is a “need.” A $2,500 mortgage bill is a “need.”
In reality, none of those things are “needs.” The people involved could live in a smaller home. They could have a much smaller pay-as-you-go mobile plan, and they certainly don’t need to blow $200 at the grocery store.
The big problem is established routines. They sign up for services and get into a routine of buying things that they want… and getting the things that they want becomes so customary that it begins to feel like a “need.”
A person in this situation might see their budget as 80% needs and 20% wants. In reality, 60% needs and 40% wants is probably generous – it’s often more like 40% needs and 60% wants when you start digging deep.
50/30/20 – From All Your Worth
A much healthier option comes from Elizabeth Warren and Amelia Warren-Tyagi’s book All Your Worth. In it, they advocate a 50/30/20 budget – 50% needs, 30% wants, and 20% savings.
This budget tends to work well for most income levels, though it may be more difficult in high cost of living areas and in situations where the person isn’t earning at least a solid income. It gives a lot of breathing room for wants and offers plenty of money for a nice home while still keeping under the 50% mark on needs.
30/10/60 – The Hypersaver Budget
Some people are aggressive about saving for a goal, and this type of budget is for them. I first heard about this budget idea from this Yahoo! article, in which the author was using it to save for a very fast retirement.
This is the perfect budget if you want to move very rapidly toward financial independence and you’re earning a strong salary. With only 30% dedicated to needs, you’ll probably need to live in a small home, and with 10% dedicated to wants, you’ll have to be a bit careful in how you spend your entertainment and hobby money.
However, this leaves 60% of one’s income for saving for the future, which means you’re going to be rapidly moving toward whatever your goals are.
My Proportional Budget
I use You Need a Budget for my budgeting purposes, so I recently fired it up and took a look at our budget from this perspective. Our budget, right now, is about 35/15/50, from what I can tell. As always, it can be a bit hard to distinguish between needs and wants, so that proportion might be more like 30/20/50. However, we are banking more than I bring home in a given year, so the 50% is pretty accurate as compared to our 2013 income taxes.
Proportional Budgets and Common Financial Situations
What do these different budgetary approaches look like when you look at common financial considerations in people’s lives? Let’s look at them through several different angles.
How do these budgets handle the daily pleasures of life? When it comes to things like going out to dinner, buying a new book, buying a new shirt, or other things like that, which budget gives you freedom? Which one locks you down?
The “paycheck to paycheck” budget is going to come out on top here in terms of having the doors open to lots of daily pleasure. If you’re budgeting in this way, you’ll have plenty of money for eating out, going to movies, buying the things you want, and so on. You’ll barely even have to think about it. If you are a person who focuses on the daily creature comforts of life above all else, then 80/20/0 is on top.
This budget offers quite a bit of breathing room for day-to-day pleasure, but it tends to come at the expense of things like a large home or a shiny new car. If you adopt this type of budget, going out to eat won’t be a major budgeting crisis.
On the other hand, this budget is going to keep you very tight in terms of those daily creature comforts. You’ll have to make a lot of hard decisions about where to spend your money on day-to-day things. The decision about whether to buy a bottle of soda actually becomes a real decision because of the tight cap you’ve put on your wants. What do you gain from that? Keep reading. If you really like your daily comforts, this budget won’t work for you.
Do you want to live in a big house? Or are you fine with a smaller home or an apartment? It really depends on what you want from your housing, but these different budgetary approaches are going to point you in different directions.
If you want a big house, this is the budget you’re going to want. Since you’re allotting so much to “needs,” that gives you plenty of room for a giant mortgage payment, allowing you whatever home you might desire. If you want a giant home and are willing to sacrifice retirement and add job stress for it, this is the budget for you!
If you’re happy with a smaller (but still nice) home, then this is probably your approach. Most people who are focusing on paying off their home – provided that they didn’t stick themselves into a house that they can’t really afford – fall into this category.
If you’re fine with a small home in exchange for a lot of other freedoms, then you’re looking at something like 30/10/60. You probably fall somewhere close to this – like we do – if you’ve paid off your home and managed to avoid inflating your lifestyle (remember, we’re roughly 35/15/50). You’re likely going to be living in an apartment or a small fixer-upper home with this approach, but in exchange for that, you’re gaining a lot of freedom over the long term in most other dimensions in your life.
I’m a big believer in emergency funds. They enable people who are focusing on debt repayment to avoid finding themselves in a yo-yo situation where they take two steps forward, then an unexpected event causes them to take a step or two back. They also allow people to handle emergencies without relying on credit, which can be very important in situations of job loss or especially identity theft.
What do these budgets do in terms of having an emergency fund?
If you’re living paycheck to paycheck, you probably don’t have one. Instead, you likely rely on credit cards for your emergency fund, which means if a life emergency does happen, you’re going to add to your current debt load. If you have an identity theft situation, you might be in a real pickle.
This budget gives you an emergency fund and the means to refresh it whenever you tap it. If you’re saving 20% of your income, you’re likely putting half of that toward retirement and the other half toward other goals, so you just choose to reroute some of that “other goal” money toward refilling your emergency fund after you use it.
The same thing is true of the “financial independence” budget, except you’ll just refill your emergency fund even faster. In fact, if you use this philosophy for a few years, almost all “emergencies” are situations that you can just casually shrug off. If you want emergencies to have minimal effect on your life, this is the route to take.
What about saving for retirement? Eventually, we all want to walk away from our jobs and spend some time with complete freedom over our day-to-day choices, with adequate financial security to do that without worry. Some budgets make this easier than others.
If this is the budget you choose, it’s safe to assume that you’ll be working until you literally can’t work any more. Social Security alone is not enough for retirement, so you’re going to be forced to continue to work in some capacity until the very end of your days. If you want to retire at all, avoid this budget.
Assuming that you’re under 40, this budget should provide more than adequate fuel for retirement. Most retirement estimators suggest that people under 40 should be saving 10% to 15% of their income for retirement and stick with that amount until retirement day, which should pop up between ages 65 and 70. Given the significant increases in lifespan that we’ve seen over the past several decades and the future medical advances coming down the pipe, you’ll have a long retirement with many years of enjoyment. This is a good budget choice for those wanting to retire with plenty at age 65.
Obviously, this is where 30/10/60 budgeting shows its strength. When you’re allotting 60% of your income to saving for the future, you’re going to save a lot for the future. You can max out a Roth IRA and 401(k) contributions and save even more in taxable accounts. If you want to retire early, this is the way to go.
“Big Goal” Savings
What if you have other big goals that are front and center in your mind? Maybe you’re thinking about buying a house in five years or so. Maybe you want to launch your own business. Maybe you want to move to another part of the country (or even to another country), but you want some cushion before doing so. This is all about life freedom.
Again, as with the retirement savings, you’re not going to be able to pull that kind of thing off with an 80/20/0 budget. You’re simply not putting cash into savings, thus you can’t achieve larger goals that require savings. If you have a big goal for the future, 80/20/0 won’t work for you.
This plan gives you the ability to both save for retirement and move toward a personal goal, but you’re going to move relatively slowly, especially if you pursue both at the same time. Even if you’re putting 10% into retirement and 10% into other goals, it’s going to take years to achieve your big dreams. They’re possible, of course, but they’re slow.
If you have a big goal that you’re deeply focused on achieving, 30/10/60 (or something like it) is the path for you. Not only can you save rapidly toward financial independence while also saving for this goal, you’ll achieve both at a surprising rate of speed. You can sock 20% of your income into retirement and 40% into your big goal, allowing you to both retire a little early and speed toward your goal. You can put 40% into retirement and 20% toward your big goal, letting you retire quite a bit early and also still move toward your dreams at a healthy clip. If you have big dreams, this is the path you should be following.
These three budgets really describe three paths through life.
If you want a lot of daily comforts and a big house, but don’t mind working until you literally can’t work any more and figure on a few major “financial crises” along the way, you’re probably going to want the 80/20/0 budget. That’s the “you only live once” approach, the “live in the moment” approach. You’ll have lots of smaller stuff that you want right now, but in exchange for that you sacrifice the ability to ever walk away from your work as well as add a great deal of professional stress to your life due to “lock-in.”
If you don’t mind a smaller house and a used car in exchange for a normal and pleasant retirement and a much smaller chance at financial crisis in life, you’ll want something like the 50/30/20 budget. This path gives you some freedom to enjoy day-to-day life, but you’ll be skipping out on the biggest and the best when it comes to major purchases. Instead, you’ll be filling up an emergency fund and a retirement plan that will enable you to walk out the door in your sixties.
If you want out of the rat race as early as possible and don’t want to stress much at all about the financial impact of switching jobs, but you’re willing to forego a lot of creature comforts to get it, You might be living in a small apartment or a small fixer-upper home, but you’ll have so much in the bank that you’ll have minimal stress at work and you have a good chance of hitting financial independence decades before you would otherwise retire. If personal freedom trumps instant pleasures and material things, this is probably the right budgetary approach.
Here’s the reality: proportional budgeting is just your own expression of what you value in life in terms of how you choose to split up your income. You work hard for that money, after all, so it’s also an expression of what your life’s energy is worth to you.
My feeling is that most people will achieve a pretty good balance by using 50/30/20 budgeting. Some others who particularly want to retire early and are more focused on life independence should look strongly at something like 30/10/60 budgeting. If you’re attracted to the 80/20/0 budget (or something similar), you’re going to be walking a tightrope for the rest of your life.
One final thought: these aren’t hard and fast rules to follow. If you think that something between 50/30/20 and 30/10/60 is right for you, roll it yourself. Try something like 35/25/40, giving you 35% for needs, 25% for wants, and 40% for savings. If you want something between 50/30/20 and 80/20/0, make something up yourself! Try 65/25/10, for example, which is where you might be if you’re house rich and maximizing your 401(k) or Roth, too.
It’s all about rethinking your finances and figuring out a “big picture” plan for what you want to do.