I’m often asked to comment on “how much someone should be saving” which always seems like asking Question #2 before asking Question #1. The bigger elephant in the room is “how are you spending your dollars” so today we’re going to talk about cash flow. OK, I know it feels like we’re ALWAYS talking about cash flow but let’s get a little more into the weeds today.
When we look at our annual spending, we can break things down into broad categories, each of which represents a portion of our income. For the purposes of baseline planning, we’ll begin by use national averages. Let’s look at those categories:
Housing – This is an “all in” what does it take to keep you in your home category that encompasses everything from your mortgage / real estate taxes / insurance / HOA fees to the exterminator / snowplow contract / gardening and your annual housing escrow (that 1% of your home value we talked about a while back). Add those numbers all together and you should fall somewhere between 20% and 25% of your after-tax income. This can be a useful parameter if you are thinking about trading your current housing situation for another.
Utilities – Most people include their heating / electric / water & sewer / phones / trash in this category and our target is 4% to 7% of your income. If there’s more room, throw in your internet / cable so you have more room in your entertainment budget. Also consider that, while this category covers your phone service, upgrading your phone is a purely entertainment expense. Shocking as it may seem, I guarantee that no one will not expire if they don’t have the newest smartphone….
Transportation – Obviously, this is going to include your car payment(s) / insurance / fuel but don’t forget things like services / tire replacement / inspection / biennial Safe Driver’s course / car registration / license renewal / Roadside Assistance program / car washes / E-Z pass(es). All in your goal here is 6% to 20% of your income. And therein lies a hiccup. Perhaps you don’t have a car payment so the total of all those other items is on the low side of that equation. Unless this is going to be the very last car you are ever going to have, you should be saving the equivalent of a car payment somewhere to replace the car that is eventually going to give up the ghost. Further, if you have an older car now, you can bet that the insurance on that newer car is going to be far more expensive than what you are currently paying.
Food & Dining Out – Combining those two aspects of eating should represent between 10% and 15% of your cash flow. It really doesn’t matter if it’s all home cooked meals or all something someone else made, this category covers whatever you digest.
Medical / Healthcare – This one is a little tougher since it represents the first expense we have very little control over – medical insurance. On top of that, we add co-pays & services we use to keep us healthy such as therapy / acupuncture / chiropractic which might not be covered by insurance. Our goal here is to keep the total between 5% and 10%.
Insurances – For many people, this can be a surprisingly expensive category so it is important to make sure we are spending our premium dollars wisely. Between life insurance, disability (short & long-term), long-term care coverage, and umbrella coverage, our spending should range from 4% to 6%. Have a little extra room – pull in the homeowner’s and/or auto insurance and give yourself some breathing room in those categories.
Entertainment – What’s in your entertainment category? How often do you venture out during the winter months? Double up on activities when it is warmer? Don’t forget summer camps / birthday parties for the kids, Netflix / Hulu / Max (no, streaming services are not necessities, they are discretionary) / club memberships. Staying between 5% to 7% is your goal.
Personal Care – Your goal here is to spend between 2% and 7% on things like haircare / nail care / toiletries / supplements / massages.
Clothing – While most of my clients don’t spend a fortune on their clothes, we all need underwear and the like. Shoes wear out and sometimes can’t be re-soled. That jacket finally falls to bits. Clothing happens – try to keep it between 3% to 10%.
Giving – Not everyone has this category in their cash flow plan so it’s really the only totally discretionary one we incorporate. Nationally, people donate between 5% to 10%.
Unsecured debt – Finally, a category that gives us some breathing room – if you don’t carry non-mortgage debt you get to distribute this 10% – 15% between the other categories where you need more cushion.
Savings – Interestingly, most people assume that the savings category stops when you retire but this can be a useful tool to free up space in your Housing or Transportation categories by moving your Housing escrow or New Car savings here. If you aren’t retired yet, this should be primarily retirement savings and represent between 10% – 15% of your income.
Those are your spending categories. You can certainly create your own but you’ll need to shave percentage points off other categories and while having a high and a low percentage gives us some wiggle room, obviously, your percentages can’t all be on the high side because, well, numbers are numbers, not Play-Doh. If you need it, working with a target can help us tame the wild spending beast.