4 Important Budgeting Rules of Thumb

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Budgeting Rules of Thumb

If you want to…

  • Keep your spending in check
  • Understand how to prepare a budget
  • Learn how much you should spend on your home

…Then continue reading my budgeting rules of thumb.

Let’s get started!

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Does a high salary mean you have a high net worth?

No. It doesn’t.

Let me tell you a quick story of a computer expert who earned a high income but did not save as much relative to his high income.

Description
Industry
Computer technology
Income
$400,000 annually (after-tax)
Age
31
Expenses
$380,000
Net Worth
$40,000

He spends about 95% of his after-tax income.

Only 5% of his after-tax income is saved.

Moreover, he had just bought a new home:

Description
Home Cost
$400,000
Monthly Mortgage
$9,500 (principal, interest, taxes, insurance)
HOA Cost
$300 per month
Total Monthly Housing Cost
$9,800

That’s when I asked him a probing question: How much time does he spend in the home? 

After several minutes of thinking, he answered and said about 20 weekends of the year. The other days he was traveling for his tech consulting job, all over the world. 

So I took a long and hard look at him and said: “Do you think you are getting your money’s worth out of this house if you only spend about half of the weekends per year in the home?” 

The answer of course is, no. 
He said that his friends and family had urged him to purchase the house. 

As we reviewed his net worth statements, we found out that he only contributes about $20,000 per year to retirement accounts. 

"Sometimes your lifestyle is too expensive, regardless of the income you earn."

Let me tell you another story of a friend of mine who earns about 10% of what this tech genius earned – or $40,000 per year. Yet, she is more wealthy than the genius.

Here’s why anyone can be wealthier than a $400,000 earning tech genius:

  • Carry no “bad” debt
  • Lives a modest lifestyle
  • Saves everything you can
  • Invest everything you earn

"Practicing healthy savings habits can give you the key to becoming wealthier than the top 1% earners in America."

To be a top 1% earner in America in 2020, you’ll need to earn more than $538,926 (pre-tax). This could vary further based on the state you reside. 

Allow me to give you the keys to potentially becoming wealthier than the 1% earners – even if your annual pay is significantly less.

monthly housing debt

1. Monthly Housing Debt


Are you worried your housing expenses are costing you too much?

A good rule of thumb to follow is this:

Rule of Thumb Description
Housing Debt
< 28% gross monthly income

Your housing debt should be less than 28% of your gross monthly income.

These expenses include:

  • Taxes
  • Interest
  • Principal
  • HOA fees
  • Insurance

As a quick refresher, gross does not mean disgusting. 

Below is an example of someone earning $60,000 a year or $5,000 per month:

Definition
Gross Monthly Income
$5,000
Deductions
$800
Net Monthly Income
$4,200
Total Allowable Monthly Housing Debt
$1,400

If you think your monthly mortgage costs are expensive because of your high-interest rate, it might be time to refinance.

One of the top refinancing companies is LendingTree.

Lending Tree:

  • Offers low-cost loans
  • Offers convenient loans
  • Offers traditional, FHA, VA and Jumbo loan options
  • Similar to a match-maker: Lending Tree introduces you to your best match

Keep in mind paying less than 28% of your gross monthly income toward housing is one of the best ways to optimize your ability to build your wealth. 

total monthly debt payments

2. Total Monthly Debt Payments


Next, we need to consider how much should you spend on monthly debt payments.

Below is the proven strategy on how much you should dedicate toward your total monthly debt payments:

Rule of Thumb Description
Total Monthly Debt
< 36% gross monthly income

Your total monthly debt should be less than 36% of your gross monthly income.

Debt payments include the following:

  • Car loan payments
  • Mortgage payments
  • Credit card payments
  • Student loan obligations, etc.

These monthly debt payments should NOT exceed 36% of your gross monthly income. 

Below is an example of someone earning $60,000 a year or $5,000 (gross) per month:

Definition
Gross Monthly Income
$5,000
Deductions
$800
Net Monthly Income
$4,200
Total Allowable Monthly Housing Payments
$1,800

As you can see, these are simply rules of thumb. 

So it’s not the end-all, be-all type of situation.

Now, if you find you are having trouble sticking to spending less than 36% of your gross monthly income, it might be time to start a budget.

There are 2 budgeting apps that I have recommended in the past:

If you are the type who likes a quick snapshot of your budget, Simplifi might be the way to go.

If you are the analytical type and prefer to review your expenses in detail, I might consider using Quicken.

To make sure you spend less than 36% of your gross monthly income on total monthly debt payments, lower your monthly costs by using a budget.

total consumer debt payments

3. Total Consumer Debt Payments


The next step is to consider how much you spend on total consumer debt.

Consumer debt counts toward your variable monthly expenses.

Rule of Thumb Description
Total Consumer Debt
< 20% of net monthly income

Some examples of consumer debt include:

  • Lines of credit
  • Credit card debt
  • Cash advances, etc. 

Instead of gross income, we are using net income for this rule of thumb. 

Using the $60,000 per year example again – you would be earning $5,000 per month on a gross basis. 

Definition
Gross Monthly Income
$5,000
Deductions
$800
Net Monthly Income
$4,200
Total Allowable Monthly Consumer Payments
$840

If you’re worried about getting your credit card spending in-check, it’s time to consider several options:

  • Looking for a 0% APR intro-period 
  • Consolidating your credit card debt
  • ‘Finding a solid budget to help you stick with your credit card payments

Then check out LendingTree.

Aside from debt consolidation services, Lending Tree also provides credit card balance transfer offers along with many other services.

It’s time to check it out.

retirement and savings contributions

4. Retirement & Savings Contributions 


The rule of thumb that I’ve often heard repeated is that you should strive to save about 10% of your gross monthly income.

"If you want to be better than the average, you have to do what the average person will not."

So, if you want to attain millionaire status, then you need to work harder and save more than the average rule of thumb. 

Rule of Thumb Description
Total Retirement & Savings
> 10% of net monthly income

If you’re new to saving and are wondering which savings account you should open to allow your cash to grow – make sure you select a high-yield interest savings account like CIT Bank.

CIT Bank offers competitive interest rates and no monthly fees, which would be a great place for new and advances savers to start.

If you already have your emergency savings account fully funded, are making retirement contributions where possible, then your logical next step would be investing your saved cash through advanced platforms like M1 Finance.

M1 Finance helps you:

  • Invest
  • Borrow at lower rates
  • Automate your investment strategy
  • Customize your portfolio based on your risk level and age
It’s time to level up. Start today.
 

Don’t let your lifestyle get to you as you earn more money (this phenomenon is called lifestyle creep).

Make sure you save as much as you can now so that it will be easier for you to achieve financial freedom in your later years.

Closing Thoughts


The rules of thumb are exactly just that: Rules of thumb.

Type of Expense Rule of Thumb

Monthly housing debt

< 28% gross monthly income

Total monthly consumer debt

< 20% of net monthly income

Total monthly debt payments

< 36% of gross monthly income

Retirement & savings

> 20% of gross monthly income

If you see yourself spending more in one area over another – that’s ok.

"The trick to becoming a millionaire is flexibility."

Do I follow these rules of thumb 100%?

No, I don’t! 

But I sure do try to make sure my spending is somewhat in line with what is recommended because I do want to reach my financial goals and become a millionaire.

"These budgeting rules of thumb are here to guide you toward your financial goals."

Work hard now so that you can enjoy financial bliss later.

Your bank accounts will thank me!

Do you have any rules for budgeting? If so, share them below!

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Fiona Smith
Fiona Smith
The Millennial Money Woman was founded by Fiona Smith. She holds her Master of Science Degree in Personal Financial Planning and has co-founded a local non-profit community teaching financial literacy to young professionals.

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