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…

{ 12 comments… read them below or add one }

Mary September 15, 2010 at 8:14 am

Best way to save on big ticket items-Wait for a sale

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Daniel September 15, 2010 at 10:02 am

Nice post, I think the best way to keep a budget is setting hard limits. Percentages should be used as a guideline, but shouldn’t be set in stone.

I didn’t use percentages when making my budget. It may be useful when looking for housing, but I used what things actually cost. It was my first budget, but now I’ll adjust accordingly, and if my total continues to come out to less than I make, I should be ok.

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joeplemon September 15, 2010 at 10:26 am

@Daniel,
Keeping your total less than you make is a great plan. Congress could learn from you. 🙂

Just curious: do you also budget that positive differential? As in earmarking it for savings or investing?

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Jackie September 15, 2010 at 7:04 pm

I think percentage budgets are good as a general guideline for people who are just starting out and trying to figure out how to get a handle on things. I give absolutely zero importance to those kinds of numbers though when figuring out my own spending plan.

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50plusfinance September 16, 2010 at 12:57 am

Percentage budgets are a good place to start. For some people with little experience in finances its a big help. As you learn you adjust to your own personal circumstances. Dave Ramsey had to put some percentages in his book or people would not know where to start.

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joeplemon September 16, 2010 at 6:11 am

@Jackie and 50plus,
Right. I agree these percentages are a good starting place, but I would still challenge those starting to clearly state their financial goals before formulating their budgets. It is amazing how many people live their lives without ever starting a budget.

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Everyday Tips September 16, 2010 at 8:45 am

I don’t really pay attention to any percentages, or even guidelines. I just know what we can afford, and we go from there. Actually, I kind of work backward. I know how much I want to put (extra) toward the mortgage each month, I know how much I want to save for college each month, etc. I then allocate my other money after making sure my savings is covered.

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joeplemon September 16, 2010 at 9:05 am

Everyday,
That is my point. If you know your goals (extra on mortgage or saving for college) and you know what you can afford, you can create a budget that synches your life with your money. Beats following a formula.

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Daniel September 16, 2010 at 12:29 pm

@ joeplemon, I don’t budget the extra out. I just stick it all in various savings goals manually. I’m way ahead of any projected savings I’ve done, so I’m kind of looking for good investment opportunities – I need a way to spend (or save) my money! Sticking it all in savings accounts sucks, and I had little confidence in myself to make solid investments. I want something exciting.

I would definitely use Lending Club if it was allowed in D.C. Maybe Congress should change that too!

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Khaleef @ KNS Financial September 22, 2010 at 7:42 pm

I don’t agree with using these percentage budgets as anymore than a loose guide. It can provide a wake up call if you are spending 30% on food and then you read that it “should” be 10%! However, you should always budget by what makes sense for your personal situation!

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joeplemon September 22, 2010 at 8:31 pm

@Khaleef,
My point exactly. The percentages can be useful guides, but my concern is that some people will follow the percentages like zombies instead of working a budget around their own financial goals.

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Hampers October 3, 2010 at 3:48 am

For me it depends on people of what they want, they use a percentage or not. And me myself i will not use a percentage i will make my own idea of how to make a budget.

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