What does the perfect & balanced budget look like?

**disneysteve** · 07-07-2008, 01:53 PM

One breakdown that I like is from "All Your Worth: The Ultimate Lifetime Money Plan" by Elizabeth Warren:

50% for "Must Haves" which are:

A place to live, utilities, food, medical care, insurance, transportation, and minimum payments on your "can't escape legal obligations". Note that they don't include clothing in "must haves"...they say that you likely already have a closet full of clothes.

20% for savings:

30% for wants:

**jIM_Ohio** · 07-07-2008, 03:44 PM

First- you must spend less than you earn. If you do that, the budget is perfect. Whether 1% less or 20% less, the budget is perfect.

Second- you need to optimize the budget- this is where it gets tricky. Maybe you start by saving 10%- easy to calculate and a nice round number. But to optimize the budget you want to get that 10% to as high as possible. it can never be 100%, so can it truly be optimized?

Third- you need a budget which accounts for all expenses- what about semi annual or semi decadant expenses. Semi annual- maybe a car tag, maybe a charitable contribution or family vacation. Semi decadant- new driveway, new roof, new car, new HVAC- things which need to be replaced once every 10-20 years.

**disneysteve** · 07-07-2008, 04:33 PM

Originally posted by jIM_Ohio View Post

First- you must spend less than you earn. If you do that, the budget is perfect.

Well, the budget would be balanced but I don't think I'd go as far as to say it is perfect.

If you are spending virtually everything you earn except for a small amount, that's far from perfect. If you are only saving 1% of income, you are never going to be able to retire, for example. I think to be perfect, the budget needs to account for all needs: immediate, short-term and long-term.

**hopefulfirefly** · 07-07-2008, 04:37 PM

Originally posted by disneysteve View Post

One breakdown that I like is from "All Your Worth: The Ultimate Lifetime Money Plan" by Elizabeth Warren:

50% for "Must Haves" which are:

A place to live, utilities, food, medical care, insurance, transportation, and minimum payments on your "can't escape legal obligations". Note that they don't include clothing in "must haves"...they say that you likely already have a closet full of clothes.

20% for savings:

30% for wants:

If I'm savings 15% for retirement (which I am) and saving toward a fully funded EF, AND, I have extra money to "save" left over...what should I do with it? Put more toward our mortgage or invest it? Or, contribute more than 15% to retirement?

One more question....should I have more in a standard savings account than just a fully funded EF? Or, is that money better invested in other means (stocks, mutual funds, etc.)?

**jIM_Ohio** · 07-07-2008, 05:11 PM

Originally posted by hopefulfirefly View Post

If I'm savings 15% for retirement (which I am) and saving toward a fully funded EF, AND, I have extra money to "save" left over...what should I do with it? Put more toward our mortgage or invest it? Or, contribute more than 15% to retirement?

One more question....should I have more in a standard savings account than just a fully funded EF? Or, is that money better invested in other means (stocks, mutual funds, etc.)?

You ask 2 or 3 questions-

if the EF is not YET fully funded, direct the extra monthly savings (after 15% retirement contribution) to get the EF to desired level quicker.

Then you need to decide- what are your goals.

1) Highest net worth possible in 10-15 years
2) An even higher net worth in 20-30 years
3) taking on less risk than average
4) having higher liquidity (while also taking on more risk)

and then weigh those goals versus your situation- if you own your own business, have varying income, or an unstable job, that may influence the advice below.

1) and 3) are complimentary- if you take the plan to do 1), you get 3); if you take the plan to get 3) you also get 1). This plan is pay off the mortgage sooner. Your net worth will spike the year the mortgage is paid off, and grow a reasonable rate after.

2) 4) and 5) are complimentary. If you want any of these, you get the other two. Key point- the net worth in 2) will be exponentially higher than in 1). This is the "invest instead of paying off mortgage" plan.

If you need to understand 1) and 2), create a networth timeline. How much extra per year could you apply to mortgage?

I will use $10,000 as an example.

In left column list the year
in second column list the mortgage balance (with no extra payments) at end of year- use an ammortization table to compare. In the third column list the equity in the house.
In fourth column list the growth of the investment (assume a 7-8% rate of return, I would assume, year over year).
In 5th column calculate net worth based on not paying mortgage off.
In 6th column list the net worth investing the difference.
Then duplicate this calculation for each year, assuming another $10k either invested or paying down mortgage. Carry this calculation through the normal ammortization schedule (30 years??).

What you should see: the path with paying down mortgage soon will increase net worth in short term faster than other option (1 and 3 above) In 10-17 years you will see this path do quite well versus the alternative. The invest the difference net worth will catch up, then exceed the pay down sooner path around year 25-35. The longer the measurement, the more the invest should win out.

Factors:
1) rates- mortgage rate vs the gains of the investment. if the mortgage rate is higher than 6.5%, I would pay down because the gains/risks taken suggest paying down is a better rate of return.
2) time- compound interest generally shows through in year 25-35. If time period is less, the mortgage payoff will be more attractive based on risks and timeline.
3) Being debt free (mortgage free) does free up cash flow which can be invested- you need to factor this into equation as well (if mortgage is paid off in year 15-, make sure the mortgage payment*12+10k is invested for remaining years. If the repayment is aggressive and pays off debt quickly (less than 10 years), the pay off for mortgage will generate a better result.
4) being debt free has less risk associated with it, you need to put a price on that risk (10k of net worth, 100k of net worth, 500k of net worth, 1 M of net worth...).
5) There is not one right answer, there are many opinions on what makes sense.

What I do:
1) We invest 17% for retirement (in 401ks and Roths)
2) we have a 30 yr fixed 1st mortgage at 5.75% and a 2nd mortgage at 7.41% 30 yr fixed.
3) We have a 3 month EF in cash
4) We are building a secondary EF to be months 4-6 or 4-12 in a more aggressive investment than cash (invested in PRPFX).
5) once we have the secondary EF funded, we will pay down the 2nd mortgage (and pay it off within 4-5 years based on aggressiveness of the payments).
6) once the 2nd mortgage is paid off, we will invest the money in PRPFX until there is a balance large enough to pay off the mortgage balance
7) at that point I would anticipate paying extra on mortgage and letting investment balance grow. Logic here is that risk profile changes-

in 6) and before the risk is having liquidity to make payments should a spouse lose job or similar. At 7), the risk becomes the investment losing value so it cannot make the payments, so to hedge that risk, pay down the debt.

Within a few years of 6) and 7) I expect to retire as well.

**mom2manyboyz** · 07-07-2008, 08:59 PM

Obviously your income has to be more than your bills.

Always pay off debt first before investing. This is because you are generally paying more in interest than you can earn investing.

The exception is retirement plans or anything else matched by your employer, because the matching makes this a wiser investment over paying off debt.

Live frugally and invest any earnings that don't go towards debt or necessities.

If you want to spend money on non-necessities, come up with an amount that works for you. There is no magic number. I average around 3% of my monthly income on non-necessities, but I am cheap. I don't drive anywhere I don't have to go. i rarely spend on entertainment. If I do spend, it is usually on something I've been wanting and planning for in advance.

I've found that the word "necessity" isn't the same to everyone. My mother who is retired and isn't required to drive anywhere thinks spending $400 a month on gas is a necessity. I spend only $100 a month on gas and I commute 65 miles round trip to work 8 days a month.

Having a budget on paper doesn't necessarily mean your finances are in order. I find that a person's attitude about spending is a much bigger indicator of financial success than a budget. Budgets are like diets, as soon as you put yourself on one... you are tempted to cheat.

What does the perfect & balanced budget look like?