In this post:
• Budgets can vary widely based on your situation
• I’ve provided some scenarios below you can work with
• Regardless of your situation, you need to spend less than you make!
You Know I Read It In a Magazine …
Sometimes parental advice goes right over the heads of the kids. And by “sometimes” I mean approximately 92.3% of the time.
But when my eldest daughter graduated from college, I gave her a copy of a magazine article on budgeting. The focus was on how much it was typical to spend, based mainly on several profiles of young people just out of school. I had read many articles over the years on spending and the need to establish a budget, so I didn’t think passing this particular one along was any big thing, and I wasn’t sure she would even read it.
Well, the feedback a few months later was that the tattered pages of that article (yes, it was old-school hard copy) had become her bible. She indicated that nobody other than her money-minded dad had given her any guidance on what it was “normal” to spend her new salary on.
Of course there aren’t any “absolute” rules, since everyone has a different situation — both income and expenses — plus very individual spending preferences. But if you’re going to establish an effective budget (see the Budget manifesto here if you haven’t already), you need to then populate it with assumptions that actually work.
I know what you’re asking – “What? I’ve gotten this far without a random music interlude?”. Ok, ok. There is so much great new music out there, and I regret that I haven’t gotten out to actually see as much as would have liked lately. But here are my favorite live acts from the past year or so: Bleachers, Houndmouth, The 1975, Mac Demarco, Ryan Adams, Buffalo Tom, Bon Iver.
And there are some excellent new releases floating around, including: War on Drugs, Beck, Courtney Barnett, Jessica Hernandez and the Deltas (shout out to a little Detroit pride! Check the latter out here.
So, You’re Earning Some Real Money …
Before you dive into a spreadsheet (and certainly before you start spending away without a plan), you should know that creating your first real budget from your first real job is important in many ways beyond just working with numbers:
– It establishes a “planning mindset” that will carry you well beyond your first budget
– Sets your personal “spending rules” that will become second nature in your everyday experience
– Lets you know what type of spending is “acceptable” (i.e. fits the overall objectives of your budget) before you get trapped into that too-expensive apartment or extravagant vacation! With proper planning, those things can be built in along the way.
Becoming comfortable with your first budget also establishes a solid base from which to expand later, whether it be a series of salary increases, house purchase, etc.
I don’t still have that article I gave my daughter, but I can propose some real guidelines that might help get you thinking. I’ve then attempted to map out a few Starter Scenarios below that demonstrate variations on these guidelines that might apply to your situation. Of course these are highly modifiable when you go to create your very personal scenario.
As you will see in the scenarios, I like to work with spending as a percentage of take-home pay. You can think of your income as what you make before taxes and deductions, but your spending obviously comes out of what you have in-pocket each month. So here we go:
Housing 30% – 40%
Many experts, including banks and real estate agents, often recommend a ceiling of 30% for housing, which applies mostly to shopping for mortgages but is also a good general rule. But let’s face it, your first housing cost right out of college might likely look disproportionate, especially if that big new job is in the big expensive city.
So a little leeway is to be expected here, and I would cautiously say that an urban rent in the 40% range might be painful but necessary depending on your location (hello New York and San Francisco — where it may be even more!).
Food 12% – 15%
Personal preference can be key here. We all like to eat, but a bit of college mentality is probably in order here. You haven’t hit the Big Time yet, so blowing a big chunk of income on fancy food is a quick way to leave you with little left at the end of the month.
Relying strictly on grocery trips for most of your meals, and avoiding a lot of gourmet extras, you should be able to keep within this range. (FYI, I bagged the same lunch for 25 years and probably saved around $100,000 in the process! That’s like $6 a day for 6,000 days).
Car/ Transportation 8% – 10%
Whether you have a car loan or plan to spend money on buses, subways, or Uber, we all need to get around. When I first graduated with my MBA, my eyes got bigger than my budget thinking my wife and I could BOTH get new cars. It only took one trip to a dealership to quash those ideas, and you should also be cautious of creating a burden you may have to live with for several years.
That being said, an entry-level car loan or lease payment can probably be had for around $250-$300 a month. (Better yet, keep that 2002 Ford Escort you had in college and drive it until it bites the dust!)
Clothing/ Entertainment/ Travel/ Gifts 12% – 18%
I’m lumping these all together for guideline purposes since we are now getting into the highly discretionary part of your budget, but you will want to consider these carefully as separate items. They are also highly interchangeable, especially in your early years of spending and saving.
For example, you may forego travel for local entertainment that better fits your budget, then shift toward that big vacation later on. Or your clothing budget is a bit higher starting out, after which you can loosen up a bit on entertainment. Also, while you want to look generous to your friends, they will probably understand that your gift budget is limited if you are spending a significant amount on rent and ramen noodles!
Utilities/ Insurance/ Other 10% – 12%
Also bunched together, the theme here is expenses you probably can’t avoid (some are fixed, like insurance, and the others somewhat variable). I’m assuming here that your car makes up the bulk of the insurance cost early on, but beware of future significant home insurance costs when making that transition.
Also remember that your cable/internet/streaming services need to squeeze into this category, and can really add up. Shop around and try to avoid duplicate services, or ones you find you aren’t fully using.
Ah, the big wild card. If you take nothing else away from Guided by Coffee, it’s that one of the foundational pillars of your long-term success is that you live below your means!
This simply means you need to spend less than you make. Notice that the percentages above, in whatever combination works for you, do not add up to 100% of your take-home pay – you want a Remainder to be able to build your savings and establish (or add to) your investments.
It should seem obvious, but if your Remainder is less than zero, you’re in debt and adding to that burden every month! One of the worst mistakes you might make is to think that your credit card will bail you out for a couple of years while you “get on your feet”, only for you to find that (a) this has established the aforementioned bad spending habits, and (b) it sucks the wind out of your ability to start growing your net worth (since “pay down credit card” now becomes a bummer of a spending category!).
In the scenarios below you’ll see that the remainder may start out at zero, but could grow to 10% or more as you capture, and not spend away, more of your growing income.
Coffee Break — My hometown actually has more than one favorite hangout (way to be diplomatic, eh?), and today’s discussion was mostly driven from Dessert Oasis in downtown Rochester, MI.
Budget Scenarios to Get You Thinking
Perhaps you fit into one of these scenarios, and maybe yours will take a lot of modification, but here I’ve outlined three potential situations and what a reasonable budget looks like:
Scenario 1 – Student Debt Drag
You’ve seen the news reports about the increasing amounts of student debt in the U.S. (Forbes even calling it a “$1.3 Trillion Crisis”), and you may be living the pain as we speak. Student loan debt is one of the fastest-growing areas of personal debt (along with car loans and credit cards), and can be quite a drag on your lifestyle as you wrestle with that first budget. But repayment is an unavoidable reality (especially since federal student debt cannot be discharged in bankruptcy!)
So in this sample scenario a loan repayment of $400/month represents a whopping 14% of net income (right up there with food). You can check out what your is, or could be, here at Mapping Your Future. (FYI, the repayment on a typical $27,000 loan at 6.8% is around $310)
Hopefully yours is less, but if this sounds about right, you need to sharpen the pencil on the other spending categories. Notice (ouch!) that some of the category totals look pretty skimpy, with little remainder at the bottom. Maybe you can find away to carve out a little extra!
Scenario 2 – Urban Rent-Sucker
My middle daughter moved to Manhattan this past year, and spent much of her free time doing the New York City apartment dance. Which means scheming the many ways to try to make living in the city work for her first paycheck out of college.
While one option, especially in NYC, is to live far away from work and endure a lengthy commute (with its own set of costs), other considerations involve negotiating the tradeoffs between the number of roommates and space considerations. She chose to live in the heart of the city by finding two roommates and sub-dividing a nice one-bedroom apartment to accommodate three private living spaces. Tight, but doable (and I became acutely aware of the big business of “flex walls”!).
This put her at the very high end of the recommended budget percentage for rent (or even higher, as shown in the example below), but it is a manageable foot in the door, for now, if living “in the middle of the action” is a priority for you. Personally, I’m thrilled with her choice, especially when I go to visit her!
Scenario 3 – Got a Promotion
Finally! A little breathing room. But what I’ve assumed, and you should too, is that only a portion of your increase goes to increased expenses. In the scenario below, notice that only $250 of the $500 net increase in pay from Scenarios 1 and 2 to Scenario 3 results in extra expense, and even here the goal should be to maintain your prior lifestyle as much as possible.
Still, you may finally be able to get that car you can rely on, or spend a touch more (but not too much more) on travel and entertainment. I think the 50% rule of thumb will serve you well over hopefully many years of pay increases. Some people also commit to allocating virtually ALL of their future increases to upping their 401(k) contributions or other investments. Very wise if you can swing it!
The Scenarios In Real Numbers:
Again, your results may vary — Start with any one of these frameworks and adapt to your situation. (After you have worked up an allocation that looks like your life, send me a note on what you named it!)