If you’ve been following along, we’ve been tracking our spending and now know what percentage of our income we spend in the different categories. If you’re just joining us, go back and read the Budgeting 101 and 102 posts to catch up! In this post, we’ll talk about prioritizing our spending in the different categories. This is where your long-term financial and retirement goals, hopes, and dreams are achieved!
ADJUSTING THE CATEGORICAL PERCENTAGES
Look back at the percentage of your income that you spent in each category. To walk through this, I’ll use the “average American” as an example of how to adjust your spending. Here’s the most conclusive data on spending from the Bureau of Labor Statistics for 2016, the most recent year we have full data for.
In 2016, the average household income was $74,664 and spent $57,311. Remember, taxes make up some of that difference. One quick word about averages – they aren’t the best at describing the true middle of American society because averages are skewed towards the higher end of the spectrum due to the top 1% of earners pulling it up; that’s why the median household income for 2016 was a much lower $57,617. Still, this is the best data we have so I use it! Just be aware of why there is such a large difference between the average and median income across America. One last average to keep in mind is the average household with debt as of September 2017 owes $131,431, with mortgages being the largest factor.
Since I was unable to find one, thorough, source to get all the info, this list is piecemealed together from what I could find. But, bear with me as I believe it enlightens the situation.
Here’s my color-coded key as to how we are doing: GOOD FAIR POOR
The average American’s spending: (Recommended %) vs. average American %
- Housing (PITI): (< 28% gross monthly income) vs. 33%
- Utilities: (5-10%) vs. unknown percentage due to usually being lumped in with housing, average monthly utilities payment is ~$320
- Food/Groceries: (5-15%) vs. 13%
- Transportation: (10-15%) vs. 16% (includes car loans)
- Insurance: (10-25%) vs. 12%
- Medical: (5-10%) vs. 8%
- Personal Care: (5-10%) vs. 10% (I combined “personal” and “other” categories together)
- Entertainment: (5-10%) vs. 5%
- Debt/Loan Payments: (5-10%) vs. – unable to find an exact percentage, but for households with debt (69% of households have at least 1 form of monthly debt payments), the average household debt is $131,431 as of 2017.
- Savings/Investments: (10-15%) vs. 4%
- Charitable Giving: (??%) vs. ranges between 3.8% to 6.8% for tax payers that itemize their deductions and make between $25,000-$100,000 in 2014.
- Miscellaneous: (5-10%) vs. 7%
- Gifts: (??%) – these categories typically aren’t tracked, but a sad article found that on average, American’s carried $1,054 of debt from Christmas. Only half of those surveyed said they would be able to pay the debt off within 3 months… another 29% said they would need 5 months to pay it off. This could end up costing ~$500 just in interest for $1,000 worth of gifts! Maybe a budget would help us plan for that event that we all know is on December 25th every single year?
- Pets: (??%) – I have no idea what would be appropriate or average here, but I’d suggest keep it to < 3-5% of your net income.
TAKEAWAYS FROM THE AVERAGE AMERICAN
We are in a lot of debt and we spend a lot of our monthly income on debt payments! Let’s highlight the worst categories.
- Housing: American’s are spending more on housing than ever before. Remember, Thomas Stanley’s research found that overspending on your house is the largest single barrier to building wealth. The difficult thing with this, is that if you’re already locked into a mortgage that is too expensive, it’s hard to change. You may seriously have to consider selling and down-sizing to an older house in a cheaper neighborhood. Remember, there’s some catches to living in an expensive neighborhood such as lawn care, home keep-up and maintenance, decorations, and homeowner’s association fees, etc. Here’s a great review of the additional costs of monthly home ownership by state.
- Transportation: In 2017, the average loan on a new car was $30,234 and the average used car loan was $19,189. These are huge numbers! When we look at these as “averages” and remember that the “average” American made $74,664 we see they are spending a huge percentage of their annual income on a car – 40% of their annual income! This is also a debt that has tended to become more long-term with some loans as long as 7 years! We’ll look at buying cars in the future in a lot more detail, but I’ve already run the numbers, and by the time people are done paying off a new car that car is worth a fraction of what they spent on it! And then they trade it in and start the process over! It’s that cycle that keeps us broke and the dealerships thrilled to see us pull in the lot! One of the proudest moments of my financial life was when I got the guy that was helping me out at the dealership to say, “You gotta give me a break, I need to make some money on this sale!” So, I did give him a break and got a great deal on a 2-year-old Toyota Corolla with moderate mileage! But I saved $2,500 in the process by haggling and about $8,000 compared to the sticker price on a brand-new Corolla!
- Food/Groceries: I once heard a guy call in on Dave Ramsey’s radio show who didn’t realize that he and his wife were spending over $1,200 every month eating out! That sounds crazy, and I believe that guy was an outlier, but I also know it’s so easy to just go out to eat instead of plan, buy groceries, and take the time to make a good meal at home. We all know what’s healthier for us and our wallets, but when we’re busy and tired, eating out is too convenient. Gotta be disciplined on this category! Food has become expensive, and don’t forget about that tip!
- Savings: After talking about the previous 3 categories we overspend in, it’s no surprise to arrive at the one category we should be overspending! Saving 4% of our income isn’t going to get it done, especially if you’re already in your thirties. If you’re reading this and you’re at least a tiny bit concerned about what your financial situation is going to be like in your sixties, then start making some changes now! It’s never too early to begin saving for your future! Look over your spending categories and percentages and decide what you want more – savings in retirement or to drive a new car today, to live in a new, big house today, to spend as much as you are on personal, entertainment, vacations, etc. To paraphrase Dave Ramsey, “If you live like no one else today, then one day you can live like no one else.”
Ask yourself, what do you really want? What do you really, really want? (FYI, I would insert a Spice Girl pic, but why?!) Just kidding, but seriously, set some financial goals that are realistic and attainable. Plan them into your spending plan / budget categories and stick to them for 1 year and see how your financial situation changes.
Albert Einstein once said,
“Insanity is doing the same thing over and over again and expecting different results.”
If you’re on this website, or any other finance/investing website, then it’s because you want to learn how to improve your financial situation. This is where you must start! You cannot continue to do the same things over and over and hope that one day something will magically change and you’ll be okay! You must take ownership of your situation and make it okay!
If you haven’t input your spending for the past 3-6 months put into the excel file from Budgeting 102 yet, do that first! But, once you’re up to date on tracking your spending work on these:
- Set some realistic, SMART financial goals. If you’re married, do it together – a spending plan is not one person’s opinion of how a family is going to spend money – avoid the tension and fights, work together! Now, for today, some generalization is acceptable, but as you near your retirement age you need to get more specific on these goals. Here’s a couple of my examples:
- Have a savings of 10-20 times our annual expenses in investments at age 65.
- Own our dream retirement home outright at some point in our 50s-60s.
- What categories are you overspending in compared to the guidelines?
- Which ones can you make right the quickest?
- Are you over-extended on your car(s)? If you’re spending > 15% of your net monthly income on auto expenses, then you are! This is a hard one, but you may need to sell your car and drive something cheap, so you can save. Remember, cars only depreciate in value while investments go up… this is called the opportunity cost of money. You can either make interest on your money or pay interest on your money. The decision will make you poor or wealthy.
- What is your housing situation? Just like with cars, this one is also difficult to face. It often means that you might have to go from being used to a really nice house to an older house. I’m not talking about moving into a dump, but honestly, we don’t all need brand new houses. Remember, whether it’s a mortgage payment or rent, expensive monthly payments mean you’re losing potential money that could be invested and grow for your future comfort – but only if you give up some temporary comfort today!
- Finally, modify your categories’ percentages to where you want them to be and begin tracking your spending for the next 3-6 months. If you find you were too conservative in a category, go ahead and adjust it as long as you’re being realistic. If you find you’re not spending as much in a category as you budgeted, determine if it’s an outlier or if you can decrease that category and transfer those percentage points to the savings/investment category.
- Finally, pay yourself first! Prioritize saving in your spending plan. I recommend starting an automated transfer through your employer’s sponsored 401k program as a great start to take advantage of their match, a Roth IRA, or a Traditional IRA. It may take a few months to get used to this money being gone, but after a while you won’t even miss it. Just get used to living off the smaller amount and feel good about being responsible and saving for your future!
Best of luck, this is where your spending plan comes alive and you start taking charge of your money!