Managing your personal finances successfully should definitely be on the top of your to do list. You know that a well-ordered financial house makes for a smoother, happier life, but the idea of getting your finances in order can be a bit daunting.
Clear up the confusion with this handy guide on how to create a plan to save, spend and invest.
Take inventory of your financial situation
Before you can determine the best ratio for managing your personal finances in terms of how much to save, spend and invest, you must take inventory. This means computing your income and expenses and using those totals to determine your discretionary income.
- Discover your total income by adding up the amount of your paycheck after taxes over the course of a year, as well as yearly payments for other income items like alimony. Include in this total infrequent infusions of cash, such as royalties and dividends. Divide the total by 12 to determine your average monthly income.
- Total your expenses (rent, utilities, bare necessities) over the course of a year, adding in periodic expenses, such as insurance payments and events like vacations. Add 10 percent onto the total for the unexpected and divide the figure by 12 to get your average monthly expenses.
- Subtract your expenses from your income, which will give you the total amount of discretionary funds that you have available each month. (If the total is a negative number, you have a budget deficit that must be resolved before you can do any saving, spending or investing.) Consult this article for ways to create a workable budget.
Build a three-month emergency fund
How much of your discretionary income you save will depend on whether you have an emergency fund or not. If you have no money set aside for a rainy day, before anything else, it’s necessary to put most of your money toward building an emergency account.
Plan to only spend 5 to 10 percent of your discretionary income and redirect the other 90 to 95 percent of the money into an emergency savings account. For instance, if you have $400 available, put away from $360 to $380 into a liquid account until you’ve saved an equivalent of at least three months’ worth of expenses. So if your expenses equal $1,300 a month, you want to put $3,900 into an emergency savings account.
If you already have the required amount of money in an emergency savings account, examine your needs for savings in the next five years. Are you planning on making any big purchases in that time period? Do you have any major financial goals, such as saving for a down payment on a new home? Calculate how much you need to save for these various items on a monthly basis over the next five years.
If you require a $10,000 down payment, you need to save $2,000 every year, or about $166 per month. This leaves you $234 per month from your $400 discretionary funds for spending and investing.
Save at least 5% of your income
The amount of money you invest in stocks and bonds and retirement accounts depends on your age, income level and your existing assets. In general, if you are 40 or older and already own a home and other assets, it’s advisable to be investing between 10 to 15 percent of your total income.
On the other hand, if you are in your 20s or 30s and are still in the process of accumulating assets, such as real estate, it’s often realistic to aim to invest 5 to 10 percent of your income and use the remaining discretionary income for savings and spending.
Don’t spend more than you make
How much you spend per month on discretionary items is a personal decision that directly affects how much you are able to save and invest. In order to decide on an amount for your budget, it’s important to look at your available funds, as well as your savings and investing goals. If possible, plan to spend what is left over once you meet your savings and investing goals each month.
Two examples of financial planning
$400 Discretionary income per month
- $166 house savings ($10,000 down payment saved over 5 years)
- $166 investment (5 percent of $40,000 salary)
- $68 discretionary spending
$800 Discretionary income per month
- $100 savings for yearly vacation
- $600 investment savings (10 percent of $60,000 salary)
- $100 discretionary spending
As you can see, the best ratio for saving, spending and investing should be tailored to your specific financial situation. Examine your income, expenses and financial goals, and use these tips as your guide.