Is My Spending Normal? Let’s Do the Math

You told yourself this month was going to be better. When you got paid you had that small rush of feeling relieved; however, by the 20th of the month you no longer feel that way. Grocery shopping has eaten into the rest of your money, as have gas expenses (that always seem to come out of nowhere), your child’s new cleats for sports, and an unexpected vet expense. These were all things you could afford, yet they added up much quicker than you thought possible. This left you wondering whether you’re spending normally or if there’s something wrong with the way you spend money.

You aren’t alone in asking that question. I’ll show you the numbers behind a typical household such as yours.

Start with the 50/30/20 formula, because it’s easy to remember

That’s the reason I started here. The 50/30/20 formula uses money you can visualize. It doesn’t refer to your salary on paper; rather, it refers to your take home pay, after all applicable deductions for federal income tax, state and local taxes, Social Security taxes, Medicare taxes, and the other items your employer deducts before issuing you a paycheck. You then divide that number into three categories. Fifty percent of that number is assigned to needs. Thirty percent of that number is assigned to wants, and twenty percent is designated for both saving money and reducing your overall debt balance faster than the minimum required payments.

Your needs are the bills that will punish you severely if you miss any payments: rent or mortgage, electricity, water, gas, heat, food, insurance premiums, fuel for driving to and from work, and the minimum payments due on all debts you have. Your wants are the soft items that you could give up living without: dinner out, streaming services, a vacation, or membership fees for a fitness club that you plan to use this time. And your twenty percent, I hope you’ll treat it like gold, because it is your emergency fund, your retirement funds building, and your overall debt balance decreasing faster than your creditors want it to.

Senator Elizabeth Warren introduced this concept in her 2005 book All Your Worth, co-authored with her daughter Amelia Warren Tyagi. I find it appealing. First and foremost, it sends your focus directly to the needs category. If your must-pay bills already consume seventy percent of your net income (your take home pay), then you have learned something valuable and difficult before you download a single budgeting program.

The 28/36 ratio: what lenders apply to you

The 28/36 ratio originated in the mortgage industry, and it bases its calculations upon your gross monthly income (your monthly pay before taxes are taken). The first number, 28, states that your housing costs should be at or below 28 percent of your gross monthly income. Housing costs include the full cost of owning or renting a residence: principal and interest on a mortgage loan, real estate taxes, homeowner or renter’s insurance policies, and any Homeowners Association fees that you may be responsible for. The second number, 36, is the maximum percentage of your gross monthly income that all your ongoing debt payments combined should equal. That includes housing costs plus auto loan payments, education loan payments, minimum payments on credit cards, and any other type of recurring debt. Lenders rely heavily on these two ratios when deciding how large of a mortgage they’ll approve for you. In essence, they provide a simple benchmark for you to evaluate your own financial situation as well. Even though purchasing a home may not be on your agenda for this year, you still benefit from knowing these two numbers as a gauge of your current financial health.

Now let me run some numbers through this process using a hypothetical example. If we assume your household takes in $8,000 per month in gross earnings (before taxes), then according to the 28 percent limit, your housing costs should be limited to about $2,240 per month. According to the 36 percent limit, all of your total ongoing debt payments should be limited to $2,880 per month. Neither of these limits represents an absolute failure on your part, but exceeding either one provides significantly less flexibility for absorbing surprise expenses or emergencies than would otherwise exist. And it’s precisely that flexibility that becomes increasingly important as you age beyond middle age.

“The 28/36 rule is still a relevant guideline, but I’d be okay straying a little outside of that framework, especially in high-cost markets.”

— Ted Rossman, Bankrate Principal Financial Analyst (source)

Is your spending normal? As long as roughly half of your take home pay is allocated towards needs and your total debt doesn’t exceed 36 percent of your gross monthly income, you’re doing fine, regardless of how it feels on the 20th of each month. However, if neither condition exists, it doesn’t mean you have failed. It merely means you have identified a problem area in your spending habits, and now you know which one it’s.

The number that beats every ratio: your savings rate

Consider it from this angle: while the formulas have their place, they’re mostly for a quick reality check. The one figure to put your eye on is your savings rate, that portion of your net pay you put aside. You can have two people in the same town with an identical salary, but the woman who tucks away 15 percent will be in a far different position than her counterpart who only puts 2 percent in the bank. It’s easy to focus on income, but what really makes a difference is the margin between your earnings and your outgo.

There’s no need to make a huge jump in one fell swoop. A better approach is to be frank with where you stand and then work on chipping away at that savings rate, a percent or so here and there. Put the extra in your account before it has a chance to be spent. In the long run, these incremental changes will serve you well; they’re worth more over ten years than any fancy app on the market.

When your rent blows past the 50 percent line

Here’s the way to see it: for a lot of people, the numbers don’t add up. The old rule of thumb that you should be able to put a roof over your head on half a paycheck is a hard sell in many parts of the country. And forgoing a coffee or two isn’t going to make up the difference. When a mortgage or rent is running more than 50 percent of what you bring home, there are only so many small adjustments to be made. The real solution is to do something about it, put in a roommate, downsize, or list a spare room for rent. That’s how you alter the equation.

One shouldn’t have any qualms about looking this in the eye. A housing expense that has run amok is a matter of structure, not of will. If the heaviest item on the books is the one throwing things off balance, then that’s where to put your focus. Put in the work to correct it and you’ll have more breathing room than from a year’s worth of pinching pennies.

Track one real month before you judge yourself

Don’t be in a hurry to label yourself as poor with your finances. Put it to the test first. Take a run-of-the-mill month and put a pen to paper for every dollar that goes out, without any self-censorship. Once you have the raw data, you can put it in order: needs, wants, the rest for savings. It’s a fair bet you’ll come across a figure or two that gives you pause, some long-forgotten subscription or an expense that looks much larger on the page than it did at the time.

You put in a month of straightforward tracking and it’ll be of more value than any general guideline. It has a way of putting an end to that nagging sense of uncertainty with hard data. When you put together a budget based on your real outlays as opposed to what you think they’re, it’s the kind of plan you can live with. And for all the unease in the process, it doesn’t last long once you have the figures down in front of you.

Photo by Bailey Alexander on Unsplash