Yesterday we discussed the reasons why you need to live within your means and some of the excuses we use for why we’re not doing it.
Today, I’ll assume you are on board with figuring out how to spend less than you make. The next question becomes how much less should you spend than you make? – aka – your cushion.
Personally I think you should start out with a minimum target of a 30% cushion. That would mean that all of your expenses (not savings) would total 70% of your income.
Example: If you earn $1000 per pay period, your spending for that same pay period should be $700 or less.
Everyone has a different idea of what your income to expense ratio should be; however, to me a good rule of thumb is
- 70% for spending,
- 10% for retirement,
- 10% for college accounts, and
- 10% emergency/vacation/big purchase.
If you are spending less than this, then great! You will meet your goals that much faster. However, any smaller cushion and you are at risk for not being able to retire, not being able to fund your kids’ college, or not being able to recover from an unexpected expense (job loss, major car repair, new roof, medical expense, etc.).
That being said- each person has different goals, different incomes, and different lifestyles. I imagine that my ratio suggestion may be different if we were talking a $1 Million annual salary than if we’re considering $100,000. A college account would get funded much faster at 10% of a million dollars/year than $100K/yr. Then again if we’re considering a $30K/yr salary and the need to support a few children, it may be nearly impossible to meet this 30% cushion.
However, as a starting point, 30% is a solid cushion to aim for and can usually be achieved (regardless of your income) if you are vigilant and intentional with your money. And even if your income is higher and these ratios mean you’ll meet some of your savings goals more quickly, why not just put the extra into retirement and maybe knock a few years off of your retirement age? It is very easy to blow any “extra” money on daily Starbucks, too many clothes, dinners out, etc. if you don’t have a target cushion in mind. A “cushion” goal helps keep your spending reasonable and allows you to spend the rest of your income guilt free.
Is your cushion goal different than my 30% recommendation?
Stay tuned for tomorrow’s discussion - Identifying Needs & How Much They Should Cost