There’s no shortage of budgeting and spending rules when it comes to personal finance. One says you shouldn’t spend more than 30% of your monthly income on housing. Another says to always save 10% of your income. Don’t take more than 4% out of your retirement nest egg. And then there’s the golden ratio budget. Here’s why Morningstar says you should consider this strategy.
A financial advisor can help you create a financial plan for your needs and goals.
This budgeting approach breaks down your monthly spending by weighing how much of your gross income goes toward your past, your present and your future.
According to Morningstar, your expenses can be broken down into this financial timeline:
- The past: Paying for things you bought/did in the past
- The present: Funding your current lifestyle
- The future: Accumulating to create future income
For example, someone earning $60,000 a year has a monthly gross income of $2,500. If she saved $250 for retirement and paid $250 a month toward her credit cards, her golden ratio would be 10-80-10, with 10% going to the past (debt), 10% directed toward the future (retirement) and 80% on present housing, food and other living expenses.
By analyzing your own spending and calculating your golden ratio, you can give yourself a budgeting checkup without getting bogged down in how much to spend on groceries, how much on gas, how much on clothing, cell phones, cable TV and other expenses. This kind of line-item budget can be confusing, intimidating and simply tedious. And it can discourage people from taking a rational look at their spending and making a plan that directs each dollar where they want it to go.
“A specific dollar amount isn’t helpful because everyone’s finances are different,” Morningstar explained. Instead, the golden ratio, “skips all the scrutinizing and itemizing and gets right to the heart of what you need to know: Is your cash management healthy? Are you saving enough?”
While there aren’t any strict limits to the budget scheme, Morningstar recommends aiming to save 20% while keeping your debt payments to 30% or less of your gross income. A 30-50-20 budget could serve as an ultimate goal over time. But you should also note that other experts recommend “the 36% rule,” which states that your debt-to-income ratio should never pass 36%.
The golden ratio budget echoes the more widely known 50-30-20 budget that recommends spending 50% of your income on needs, 30% on wants and 20% on savings and debt. The “needs” category covers housing, food, utilities, insurance, transportation and other necessary costs of living.
Another approach, favored by behavioral economists, recommends skipping budgeting entirely because most people simply won’t stick to any kind of formal spending plan. Instead, they suggest automating your saving toward specific goals and amounts and then feeling free to spend the rest.
“If your debt is healthy and you have achieved your savings goal, then you can spend the rest guilt-free! It doesn’t matter if you spend it on restaurants or vacations or clothes or model trains,” Morningstar said in an article, which set a 10-60-30 ratio as a personal goal. “If your past and future are in good shape, then you can skip all the itemizing and agonizing and just enjoy your life and your money.”
The golden ratio budget breaks down your monthly spending by weighing how much of your gross income goes toward your past, your present and your future. This approach can help put your finances on a timeline and adjust your goals based on short-, mid- and long-term needs.
Tips for Financial Planning
- A financial advisor can help you compare different budgeting strategies for your financial plan. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- A key to budgeting is having a good grasp of your financial timeline. If you need help setting goals, this guide breaks down retirement goals by age.
Photo credit: ©iStock/fizkes, ©iStock/shapecharge