Beware of Percentage Budgets

by Joe Plemon on September 15, 2010

You have seen those percentage budget plans which deftly tell you what percentage of your budget you should spend on which categories.  Yes, they are a good guide, but you need to beware: giving too much credence to those percentages could get you in trouble.

For example, the following percentages are recommended in Dave Ramsey’s Financial Peace University book:

Charitable giving 10-15%
Saving 5-10%
Housing 25-30%
Utilities 5-10%
Food 10-15%
Transportation 10-15%
Clothing 2-7%
Medical/health 5-10%
Personal 5-10%
Recreation 5-10%
Debts 5-10%

Why these percentages could be misleading:

  • Don’t fit high or low incomes.

Dave Ramsey rightfully points out that these are only recommended percentages and that if you have an unusually high or low income, they could change dramatically. For example, a couple who earns $20,000 annually will probably need more than 15% ($250 a month) for food while a couple who earns $200,000 will spend much less than 10% ($1667 a month) for food.

  • May encourage auto-piloting.

It would be an easy thing to make budgetary decisions based on these percentages instead of your own life and goals. Personal finance is intended to be personal, meaning you need to carefully think through all of your income and all of your outgo, and make it fit what YOU want instead of what some recommended percentages say.

  • Could detract from following through with your own goals.

Do you know your short term financial goals? Your long term goals? If not, why not? Your finances are not simply dollar amounts; they represent your value system. When Bob at Christian PF writes My Strategy for Giving Away Millions, he is planning his money (budget) based on his goals, not vice versa.

  • Might be a nerd trap.

Some people (nerds…raise your hands) love numbers to the exclusion of what the numbers represent. One can have a perfectly balanced budget on a perfectly balanced spreadsheet with perfectly proportioned recommended spending, but if those numbers don’t translate to real life, they are only an exercise in math…and frustration.

  • Could be a license for spending more than you should.

If you have debt that is weighting you down, a percentage budget might give you excuses for spending money on such things as car payments and recreation instead of funneling that money into an accelerated debt reduction plan. Again: your budget needs to reflect your goals, not a formula.

How percentage budgets can help:

  • Prevent overspending on big ticket items.

Many people could have avoided real estate catastrophes if they had only limited their house payments to 25-30% of the income instead of stretching every penny in order to make their house payments. In the same way, total car payments of not more than 10-15% can give some sanity to those who think they need two or three new cars.

Concluding thoughts

Percentage budgets can be helpful guidelines, especially to avoid overspending on big ticket items, but remember: they are merely recommendations. Because budgets represent your goals and your values, start by clearing establishing your financial goals and then tailoring your budget to fulfill those goals.

Then, and only then, will your money truly match your life.

In your budget, how much importance do you give to “recommended percentages”?  When do these percentages help?  When have they been a hindrance?

Creative Commons License photo credit: TheTruthAbout…

email

{ 12 comments… read them below or add one }