Advice on how to budget often includes budget rules that you can use to guide you on how much to spend on different spending categories.
Typically, the three categories are:
Needs: This includes accommodation, groceries, utility bills (electricity and water) essential transport, essential clothing, healthcare and insurance.
Wants: This includes spending on entertainment, alcohol, things for your home, gifts, clothing wants and jewellery, hair styling, beauty treatments, an expensive car, your hobbies, travel, eating out or treats, and so on.
Savings and debt repayment: This includes paying down debt, saving for retirement, savings for shorter term goals and saving for your emergency fund.
A common one cited in the United States, for example, is the 50:30:20 rule widely attributed to US senator Elizabeth Warren and her daughter, Amelia Warren Tyagi, authors of All Your Worth: The Ultimate Lifetime Money Plan.
In terms of this rule, you should spend 50 percent of your after-tax income on your needs, 30 percent of your income on things you want and 20 percent on paying down debt or saving.
While the 50:30:20 rule sounds like a simple one to follow and saving 20 percent of your income should be a goal, the rule is not suitable for everyone.
Many South Africans have needs that make up a much greater proportion of their income and/or have debt that requires repayments in excess of 20 percent of their after-tax income before any savings are even considered.
The 50:30:20 rule has been adapted in many ways to simplify it and to suit people in different situations. For example, for those who do not want to separate out their spending on necessities and luxuries, the 80:20 rule proposes that you set aside 20 percent of your income for saving and use the remaining 80 percent for both your needs and discretionary spending.
Alternatively, for those whose debt is in control and can afford to save, but want to prioritise being debt free, the 70:20:10 rule suggests you allocate 70 percent of your income for essentials and discretionary spending, 20 percent for savings and 10 percent to paying down debt.
A variation of this is the 40:30:20:10 rule which proposes that you spend 40 percent of your after-tax income on necessities, 30 percent on your wants, 20 percent on savings or paying off debt and 10 percent to charitable giving or meeting financial goals.
The 65:20:15 rule is one often cited in South Africa and suggests that you set aside 15 percent in savings and investment, spend 65 percent on essential expenses and 20 percent on things you want to enjoy life.
Budget rules should be tailored to your personal circumstances.
Lower earners in South Africa tend to spend more on groceries and transport – for those earning R3 000 or less, data from one bank shows groceries account for on average 34 percent of spending, with transport another 14 percent, making up 50 percent of after-tax income before housing, clothing or medical care are considered.
The same bank’s data shows that with earnings between R3 000 and R15 000, the spend on groceries is on average 19 percent of income, with transport at nine percent, and housing and insurance together making up 25 percent.
At higher incomes groceries account for a lower percentage of spending – but medical insurance accounts for a larger proportion. For example, on incomes of R40 000 to R70 000 a month, 13 percent may be spent on groceries, but 18 percent on healthcare. If you are, for example, a medical scheme member in poor health, you will most probably be spending more on contributions.
Similarly, families educating children at private schools may find education costs consuming an extraordinarily large proportion of their after-tax income.
Spending rules will also depend on your age. When you are young and starting out in your first job, you may find yourself spending more on your accommodation or a car than other age groups. When you have to support family or start your own, your spending on groceries, healthcare and insurance increase.
Retirees may also spend more than other age groups on essentials such as groceries because they should no longer have debt, family commitments or a need to travel to work. Pensions are also typically lower than what you earn when you are employed and savings are typically reduced as retirees are living off their retirement savings rather than contributing towards them.
If you have a lot of high cost debt such as credit card debt, an overdraft or an unsecured loan, your spending proportions will also be skewed. As your debt spirals, your debt repayments will increase leaving less room for spending on wants and even on necessities.
This is also the time your focus should be on paying down that debt as quickly as possible. So you should reduce your discretionary spending to the barest minimum and even try to save on necessities to channel any money you do not need into repaying the debt. The sooner you pay down the debt, the sooner you will start saving on interest and have more to spend and hopefully some left over to save.
If you have little or no emergency savings and/or little or no retirement savings, you will also need to bend these common savings rules to favour your savings until you have saved enough to cover any emergencies and/or your retirement savings are back on track.
Cut back on discretionary spending and even trim necessities while you focus on getting back on track.
You should also do this when you want to accelerate your savings for a goal, such as a wedding or to travel.
An often-cited rule of thumb is the one that suggests you spend 30 percent of your after-tax income on accommodation costs – your home loan, rates and insurance or your rent.
Another often-cited rule of thumb is that you should aim to spend no more than 30 percent of your income on debt repayments.
Again rules of thumb may need to be adapted depending on your circumstances. You may need a bigger home if you have a bigger family. You may prefer to spend more to live closer to work and less on travelling to work.
If you are spending 30 percent of your income repaying credit card, vehicle finance and other shorter-term debt and 30 percent on rent, you are already at 60 percent and will most likely struggle to meet your other needs and to save. Use these rules of thumb as a guide and make sensible decisions around them depending on your needs.
