How will your budget change as your financial responsibilities shift? That’s what we’re looking at this week.
This week’s question is from Sara:
I’m curious about whether your budget should change as life changes. I have two little kids so have high daycare costs, and also am paying off student loans. We are expecting to save more and have more money for a higher mortgage once loans are paid off and we get raises and kids leave daycare (my husband and I are both in the public sector so we have predictable “raises” and stable jobs). Is that dangerous wishful thinking though? More generally, how should we allocate our income (what per cent to mortgage, savings, etc.)?
This is what individual experts have to say generally about an issue that affects each person differently — if you want personalised advice you should see a financial planner.
Flexibility Is Key in Budgeting as in Life
When it comes to your finances, there’s no one-size-fits-all approach. This is true across groups of people as well as in an individual’s life. That’s why it’s best to think of your budget as a living, breathing document that will need tweaks and changes as you grow older and your income, priorities and circumstances change.
“A budget is not something you can set and forget, you constantly have to review and update it as your income and financial situation change,” says Cameron Huddleston, the Life and Money columnist for GoBankingRates. “The most important thing is to have a plan, but know that it will change over time as your situation changes.”
So, for example, while a large percentage of your budget might be dedicated to paying for daycare right now, that will eventually lessen. With that will come some relief, and the need to reformulate your plan.
“Once that money is freed up, then you need to examine where you stand financially,” says Huddleston. “If you do not have an emergency fund, that is one of the first things you need to think about starting.”
The standard advice for an emergency fund is to have three to six months worth of necessary expenses saved up, but if that seems too burdensome, Huddleston recommends having enough saved to cover your insurance deductibles (home, car and medical) in cash so you don’t have to put them on a card and incur the high interest. That should give you some peace of mind as you work toward a larger cash cushion.
The current bull market’s longevity has people worried. It all has to end some time, and some economists are predicting a recession by the end of 2020. Assuming that holds true, that gives you around two years to get your finances in order. What should you be prioritising?
Your next priority should be saving something for retirement. Ideally you’re setting aside around 15 per cent of your income for retirement, including super. Huddleston recommends increasing your retirement savings once your childcare payments let up rather than putting that money toward your mortgage, though, of course, that decision is ultimately up to you. She says 28 per cent of your monthly income is a standard mortgage payment, though something lower than that (say, 25 per cent) is obviously preferable.
Greg McBride, chief financial analyst of Bankrate.com, says that when it comes to structuring your budget, the worst thing you can do is base it on your anticipated income, rather than your actual income. “Housing is a common area where people do this, purchasing a home they expect to ‘grow into’ as earnings increase,” says McBride. “Even if your raises are predictable, there could be other factors you can’t anticipate now that might come into play before those future raises and derail your plans.”
While you may be counting on steady raises and extra cash from daycare costs, you shouldn’t base your mortgage on those projections. Because life will happen, and you may be unable to adequately afford payments.
Automate What You Can
If you want something easy to follow, the 50/20/30 budget system is as easy as it gets: Spend no more than 50 per cent of your income on essentials (housing, food, transportation), put 20 per cent toward savings and debt reduction and spend the last 30 per cent toward whatever you want. That might include making additional debt payments or putting a bit more toward retirement. It’s up to you to play with.
“I don’t think it’s wishful thinking to think that they can save more,” adds Huddleston.
So, first, focus on your savings, “ideally through payroll deduction, direct deposit and automatic draft from your checking account,” suggests McBride. This is especially important with children to support. Then decide how to allocate what you have left.
For example, you may use the excess to put toward retirement, your future home or to pay down your student loans. Speaking of which, they can obviously feel like a huge burden that’s weighing on you and causing stress. But it’s likely better to prioritise your retirement investments than paying them off sooner, because you’ll likely get a higher rate of return. And the sooner you start saving for retirement, the less you’ll actually have to put away in the long run, because that money compounds.
If you find that they’re not manageable given your current situation, you can look into refinancing or spreading out payments over more months, which will lower your payment amount (though increase how much you’ll pay overall). And stay away from any company that promises to “help” you pay off your loans faster or for less money than you currently are — it’s likely a scam.
Automate as much as you can, as McBride suggested. When all of your bills and other responsibilities are taken care of automatically, you’ll have a much better sense of how much you actually have to play with month-to-month.
As those bills change, so will your budget. As long as you’re keeping track, you’ll be fine.