The Most Important Part of Your Budget

I think budgeting has a bad reputation, mostly because we treat our budgets like a set of thrift store shackles that are a size too small.

They’re restrictive! They require updating! They force you to open Microsoft Excel!

Ew, right?

I disagree. Wholeheartedly! And it’s not just because my budget and I have become BFFs.

The reason I love my budget now is because it reaffirms my beliefs and value system about myself.

If my budget told me a different story (like, “You’re inadequate. You’re overspending. You value the wrong things.”), I don’t know that I’d feel so positively about it.

Most first-time budgeters fail because they start with the budget.

The budget is the manifestation of your values in the form of 0s and 1s in a spreadsheet. If you try to create the budget before you clarify your values, things will feel (and end up) misaligned.

Why people pursuing FI often don’t need budgets anymore

The purpose of the budget is to give structure to your financial life – like the scaffolding of a building that shows you how big the rooms will be, where the windows are, how you get in and out – you know, the big stuff.

A budget is not supposed to guide day-to-day decisions.

That would be like using the architectural blueprints of your house to determine what color the pillows are and what scent the candle is burning in the kitchen – it’s supposed to be a big-picture guide, not an in-depth interior design manual.

I think the hallmark of a truly financially independent person with an excellent grasp on their spending is the lack of a budget.

Imagine being so closely attuned to your goals – your values – that you don’t need a spreadsheet to dictate whether it’s a “$5 oat milk latte” or “Folgers-in-a-freeze-dried-packet” day.

“People are too busy asking $3 questions to bother with asking $30,000 questions.”

Name that personal finance guru hot take!

This is, of course, a Ramit Sethi concept: That too often we focus on the little shit and get caught up in the details, when in reality the big, structural decisions require more intense attention.

So no, it’s not necessary for you to consult your budget for every decision you make – in fact, I hope you aren’t. That sounds exhausting.

If you struggle with sticking to the well-intentioned plans you set for yourself on Sunday mornings after Saturday nights spent in overpriced restaurants with monosyllabic names like STIRR and HOUSE, it’s possible that you just need to ask less of your budget.

The most important part of your budget is that it sets the big picture plans for how you plan to live your life

You could probably get away with making five broad categories and leaving it at that. If breaking things down into an insanely granular view (coffee shops! Artisan bakeries! BOBA TEA!) stresses you out, try this:

1. Housing

2. Transportation

3. Food

4. Living Expenses

5. Entertainment

The sixth, implied category that’s left is investing.

If you ask me, the ideal split to strive for is this:

1. 50% goes to…

   1. Housing

   2. Transportation

   3. Food

   4. Living Expenses

   5. Entertainment

2. 50% goes to…

   1. Investing

That’s right. I suggest trying to fit your five major categories into half your income.

You may be in a position right now where your structural expenses are simply too high to do this. For example, if you make $5,000 per month and your rent is $2,500, you’ve already used up half your income on category one.

That’s okay – a 50% save rate may not come easily at first, and it might require shifting around some big, uncomfortable puzzle pieces – but if I had to venture a guess, most of your spending comes from areas 1-3. It doesn’t make sense to cut from a small entertainment budget to try to buy back space in your budget when you’ve got 40% of your income going to the roof over your head. It’s simply more efficient to trim the big categories first.

All too often I hear people get hung up on the details of where to file expenses

“I got a $30 gift for a friend but I don’t have a gift budget!” * gasp *

What should you do? Well, I’d file it under whatever broad category fits it best. Maybe that’s living expenses. Maybe it’s entertainment. At the end of the day, where you file it in your budgeting system ultimately doesn’t matter. Because when you zoom out even further on these five major categories, what it really looks like is this:

1. Stuff you have to pay for every month no matter what

2. Funds reserved for everything else

Things that fall into bucket #1 are the predictable, recurring costs that don’t vary, but can sneakily eat up a lot of your income.

Everything else goes into #2.

Honestly, if even the five-category method is too stressful, you can just break it down into 1 and 2.

If you’re aiming for spending 50% and saving 50% of your income, the gap between your structural expenses and the 50% mark is what you’ve got leftover to spend on whatever you want.

Example time, obviously

Let’s say you make $65,000 per year.

$65,000 per year, after taxes, is around $53,300 – or $4,441 per month. If you were aiming for the structure above, you’d give yourself $2,220 of breathing room per month to spend in whatever way you saw fit, and saving $2,220 per month.

A perfect hypothetical breakdown would look like this:

1. Housing: $977.02

2. Transportation: $400

3. Food: $450

4. Living Expenses: $200

5. Entertainment: $200

And there you have it: $2,227.

I don’t know about you, but I don’t think that looks like an overly oppressive budget – and it would enable you to save half your income.

If you were to split it into the two-category system, it’d probably look like this:

1. Stuff you have to pay for on a predictable, recurring basis: $1,377 (Housing + Transportation)

2. Everything else, that’s more fluid and unpredictable between categories: $850 (Food, Living Expenses, Entertainment)

See? It doesn’t have to be #perfect, it just has to create a basic framework.

“But Katie, I have debt. I can’t afford to save or invest half my income.”

Use the same equation and, depending on your interest rate, divvy up your remaining “save and invest” 50% between investing and debt payoff.

A good rule of thumb is that interest rates <5-6% should be paid off with the minimum payments, and any extra money should be invested instead (because you’re likely to make more than 5% in the market).

If your interest rate is >5-6%, you probably want to prioritize your debt and throw all 50% at the debt.

So, in our example above, the spending would stay as is, and the remaining 50% ($2,220) would be split between – for example – student loan payoff and investing.

Pretend our friend with the $65,000 also has a $500 student loan payment. They’d put $500 of their $2,220 toward debt, and the other $1,720 would be invested (assuming the student loan payment has an interest rate of less than 5%).

Saving half your take-home pay as priority #1 (and then figuring out how you spend the rest) is a better approach than deciding how you want to spend first and saving whatever’s left over

It also simplifies your spending equation because you know you have a pre-determined amount that you’re comfortable spending that still fulfills your saving and investing goals, instead of leaving your investing goals as the afterthought.

If budgeting feels insurmountable to you, simplify it by choosing the five-category or two-category approach and shoot for the 50% mark. Even if you fall short, you’ll probably still save far more than the average American who barely saves 5%.

(And if your structural expenses like your rent and your car are way too expensive to ever have a prayer of being under 50%, maybe it’s a sign it’s time to make a few easy changes that can have an insane impact on your financial situation.)