Excerpt: 'The Big Payoff'
Following these three simple rules — "the Budget Commandments" — should go a long way to helping you stretch your budget:
Budget Commandment I: Thou Shalt Live on One Income, Not Two
You can learn a lot from single mothers. Single mothers have to get by on one income. They have to take care of at least one, sometimes several, dependents. It can be tough living on one income in this economy. Yet more than one- quarter of the nation's 73.5 million children live with one parent and about 5.6 million moms stay at home, according to the 2005 Family and Living Arrangements from the U.S. Census Bureau. If you're a two-income family and you can manage to live on one income, the path to your financial dreams will be that much easier.
Whether you're newlyweds or have been married for years, the best way to budget is to plan to live on less than you both earn. If both of you are working, try to pocket one paycheck. Try using one income — probably the higher one — to pay the mortgage or rent and other house hold expenses, as well as car loans, and child care, food and all other bills. Direct the second income to savings. But don't skip contributions to retirement plans. If it's impossible to pay all of the bills and contribute to a retirement plan on one income, then dip into the second income — but make sure you are saving as much as possible of that money for retirement for both of you, as well as for emergencies (in case the sole breadwinner loses his or her job).
The decision to quit a job and live off of one income shouldn't be made without reflection, research, meditation, and possibly a short vacation. Women who are thinking about dropping out of the workforce should talk to others who've made that transition. Check out Mothers & More, a national network of 7, 500 stay-at-home moms before you resign from your position, just so you get an idea of what life holds in store for you if you choose that route. The workforce is like a plane at 20,000 feet — it's easier to drop out than it is to drop back in. And the trip down can be exhilarating, but you'd better know where you are landing and you'd better have a parachute. (You can learn more about the group at www.mothersandmore.org.)
Living off of one income may seem impossible if you've been counting on that second paycheck. Most couples decide they can only afford the house they want or pay tuition for their children to attend private school or take family vacations each summer if both spouses are working. But living and depending on two incomes can be dangerous. Your budget is set — and often maxed out — on that combined income. What happens if one of you gets sick or loses his or her job? How long can you afford to pay your mortgage or rent and other bills on one income? What if you get pregnant? Even if your company offers some paid maternity leave, what if you decide you want to stay at home longer?
If you've based your budget for essential monthly expenses on one income — or even if you just live off one and a half of your combined earnings — you'll have enough money put away to cover those difficult periods. You may not be able to stash any cash in your savings account during those times, but you won't have to worry about how you'll pay your mortgage either.
By living on one income, you can also use the other income to fulfill other dreams and goals: staying at home with your children, going back to school, or starting your own business. The best part is, if you never need to dip into the second income, you may be able to tap into a sizable savings account that could help you whittle down your children's college bills and build a large nest egg for your retirement. As financial adviser Mo Barakat says, "The couple that can manage to live off one income and save the second is the couple that is headed toward financial wealth. That's the golden formula."
Many one-income couples may feel there is nowhere left to cut. Perhaps you can both look at how you spend your time and see if you can add a part-time job or do some freelance work to add to your earnings — and save that sum. Maybe you can't make a dramatic change in your spending and saving habits immediately, so start gradually. Instead of spending two incomes (or one income, if there is a sole breadwinner) down to the last dime each month, stash away 5% of your pay, then 10%, and work your way up to 20 to 25% of your gross income.
You may still think that is impractical or impossible in your situation. It may seem that way at first, but keep reminding yourself of the financial rewards. Save a portion of your income (whether it's 5%, 20%, or an entire salary) and invest it for the future. You'll be that much closer to your financial goals.
Budget Commandment II: Thou Shalt Pay Thine Own Self First
The best way to start to save is to pay yourself first. You've undoubtedly heard this before, but do you and your spouse actually adhere to it? Do you have money automatically deducted from your paycheck each month for your 401(k) plan or other retirement savings programs? Are you contributing the maximum amount that your employer allows — or at least up to what the company matches if that is offered? Do you make monthly contributions to a traditional or Roth IRA? Do you have three to six months of living expenses socked away for emergencies?
Make sure your savings are diversified. Savings shouldn't be limited to retirement planning. Many couples contribute to the retirement plans and then stop putting any money away. They think that fulfills their savings obligation for the month. It's also important to save for a down payment on a home or a car or other items like unforeseen medical expenses.
If you haven't done so already, you need to start a savings account and deposit a set amount each pay period in an interest- bearing savings or money market account to cover these costs. Also be sure to take advantage of other employer- sponsored benefit savings, such as flexible spending accounts, which help cover uninsured medical costs and also lower the taxes you'll pay on payroll income.
The 60% Solution. Here's a great way to allocate your savings. Financial writer Richard Jenkins, editor in chief of MSN Money (http://money.msn.com), has boiled 20 years of complicated budget calculations into a simple conclusion: He and his wife limit all essential spending to 60% of their total gross income. Most budgets have a great deal of detail. Web sites like MSN Money, CNN Money, Bankrate.com, and a host of others have budget calculators you can plug into to help you determine how much of your income you spend on housing, transportation, child care, food, and other necessities. Some calculators will analyze your spending on these items, for example comparing it with a national average based on your salary and the number of people in your house hold. But as Jenkins points out, in most budgets, there is too much attention to detail and not enough attention to the bottom line. Writing down every dime that you spend on a latte, your favorite CD, or a much-needed manicure won't necessarily prevent you from falling into financial ruin, especially since most of the biggest financial headaches are those really big expenses — like putting a new roof on your house.
After reviewing his own family's finances, Jenkins came up with a faster and easier way to structure their budget without having to account for every penny. He decided they needed to keep "committed expenses" at or below 60% of their gross income (their salary before taxes) to come out ahead at the end of the month. Take a look at the Budget Worksheet at the end of the book first. Depending on your "commitments," the number may be higher (probably much higher) or lower for you and your spouse. But 60% is probably a good place to start.
Committed expenses (covering 60% of gross income) would include:
• All taxes (including taxes withheld from pay)
• Essential house hold expenses: rent or mortgage, home insurance, real estate taxes, phone, utilities (gas, water, electric), other household expenses
• Basic food, clothing, transportation: groceries, dry cleaning, auto loan, auto insurance, gasoline
• Insurance premiums: health/dental, life, disability, other
• All bills (child care, education, other committed expenses)
Then, divide the remaining 40% of your gross income into four chunks — split evenly or weighed according to your objectives:
Retirement savings. Have automatic payroll deductions (or deductions from your checking account) of at least 10% of your income made into a 401(k), 403(b), Roth, or traditional IRA, or self- employed retirement plan (SEP-IRA, SIMPLE IRA, solo 401(k)).
Long-term savings/emergency fund. Invest 10% in stocks and bonds, but keep most of this money liquid so that cash could be available in case of emergency.
Short-term savings. Money should be direct-deposited from your paycheck to a money market or interest-bearing savings account. Use this money to pay discretionary expenses for vacations, repairs, new appliances, holiday gifts, charitable contributions, and other irregular, but predictable, expenses.
Fun money. Spend it on anything you like, but don't exceed 10% of gross income. You could also make a budget for just three categories: committed expenses, fun money, and irregular expenses — and save 20% of your income for long-term goals, such as retirement and/or college savings. If you can manage to save 10 to 20% of your income, you will be amazed at what you will be able to accomplish in the years ahead. You can make your own 60% Solution Budget using the worksheet at the end of the book.
Remember that this budget is based on your gross income, not after- tax income. Still, keeping Committed Expenses to 60% of your gross income may be impossible, at least initially. That's probably because you're overcommitted. Many couples have too much mortgage, too much debt, big car payments, and private school tuition that they really can't afford. If you're in a position where you receive an annual raise or bonus above the rate of inflation, Jenkins suggests you just hold your Committed Expenses steady for a while and let the raises or bonuses reduce the percentage over time. Otherwise, you will have to look at ways to reduce those expenses.
For couples saddled with student loans and huge credit card bills the first impulse may be to let saving for the future take a backseat while you pay off your debt. But considering the amount of money you'll need for retirement — as much as 100% or more of your current income by the time you reach age 67 — it's important to start saving as early as possible. If you don't feel comfortable contributing a full 20% of your income to retirement and long- term savings, at least stash the maximum into your employer's retirement savings account, an IRA or self- employed retirement plan. Any money left over from that 20% pot can go toward paying down your debt.
This is not a rich person's budget. Says Jenkins: "I've gotten mail from people who are making it work on as little as $31,000 per year. The key is keeping a lid on housing and transportation costs."
With the "60% Solution," you don't really need to track your expenses because your checking account balance should ideally be equal to the amount of money that you will spend each month. A lot of couples budget that way — spending down to the last dime in their checking account each month — the problem is they don't make provisions for savings first.
In following the 60% Solution, you may find that Jenkins is right in his assertion that the real secret to building a budget isn't tracking what you spend (any more than counting calories is the secret to losing weight). He believes, as I do, that the key is "creating a sustainable structure for your finances, one that balances spending and income and that leaves enough room to handle the unexpected."
Budget Commandment III :Thou Shalt Stay Out of Debt
Recognize your debt dilemma. The main reasons so few couples are able to save are simple: they overspend and they are in debt. It's not rocket science. Many couples today are taking on far more debt than their parents did a generation ago to provide the same standard of living — and adding even more debt to buy a house in an expensive neighborhood and to send their kids to private school and then to college. "About one in every seven families is in the same kind of shape that you are: having trouble paying bills at the end of the month, feeling extreme financial pressure, worried whether or not they're going to be able to keep the house and the car," says bankruptcy expert and Harvard Law professor Elizabeth Warren. For most couples, the only way to cover the mortgage, car loans, and other debt is for both spouses to work, and still they are stretched too thin. Recognizing some of these early warning signs of financial trouble identified by the National Foundation for Credit Counseling (NFCC) could prevent you from suffocating under mounting debt.
• You're behind on the basics, like the mortgage or rent, and utility bills.
• You're using credit to buy items you should be able to buy with cash, like groceries. (You may say you're using the plastic to get frequent flier miles or rewards points that the card offers. But if you're not paying that credit card bill in full each month, you're paying way more than that free airline ticket or stereo would be worth.)
• You're skipping payments on one debt to make payments on another bill.
• You're receiving overdue notices or telephone calls from bill collectors.
• More than 25% of your take-home pay is used to pay back credit card debt.
Don't just suffer; take action and get help. Follow the NFCC's advice: Call creditors and let them know that you're having problems. Explain your situation and what you're doing to pay off your debts. Depending on the creditors' policies and your situation, credit and payment history, you may be able to negotiate your next payment or a lower interest rate. Remember, your creditors would rather keep you as a customer than lose you to bankruptcy and foreclosure.
Excerpted from The Big Payoff: 8 Steps Couples Can Take to Make the Most of Their Money — and Live Richly Ever After by Sharon Epperson. Copyright, 2007 HarperCollins Publishers.
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