DW and I first got serious about FIRE in 2002. I became aware of the “50-30-20 budget” sometime between 2005 and 2008 but didn’t dig into it because we were focused on saving and investing. Recently I checked out the source, All Your Worth (2005), by Elizabeth Warrant and Amelia Warren Tyagi, from the library. This is a review, along with my take on how it applies to the FIREd population.
Notably, the authors don’t use the term ‘budget’ to describe their method; they say “balance” or “balanced money formula”. And this is not a traditional budget – there are three categories: Must-Haves, Wants, and Savings. The plan is to have those categories as 50%, 30%, and 20% of your take-home pay (after federal/state/municipal taxes, but before health insurance deductions and property taxes. Employer retirement plan or pension contributions are added to both take-home pay and savings.) Warren and Tyagi explain the reasons behind those percentages on pp. 26-33. 50% Must-Haves are sustainable, safe (for when things go financially wrong), and have been tested over time. The book is based on more than twenty years of intensive research (p. 4).
Must-Haves: A place to live, utilities, medical care, insurance, transportation, minimum payments on can’t escape legal obligations (for example, a cellular contract or child support), basic food. Credit card debt is handled under Savings.
Savings: Pretty obvious. After-tax savings, tax-advantaged savings, extra payments for mortgage/car loan/student loan. Subtract credit card debt.
Wants: Everything else!
There are easy worksheets for these and help columns for each. And examples of what spending too much on Must-Haves and too much on Wants look like.
There are two schools of thought on controlling spending: multiple frequent small leaks (the “Latte Factor”) and large expenditures (car, house, student debt). All Your Worth is firmly in the large expenditures camp. To bring spending in balance with their formula, they go through a series of steps, “Cut the Easy Stuff” (shop around for insurance costs), “Cut Where It Hurts a Little” (sell your car and buy used), and “Consider Radical Surgery” (a different job).
They talk about Wants, and are big supporters of cash and detractors of credit and debit cards.
The lifetime savings plan is nothing new or radical:
Stage 1: $1,000 emergency fund
Stage 2: Pay off “Steal-from-Tomorrow” debt (basically, everything except your mortgage/car loan/student loan(s))
Stage 3: Six-month emergency fund
Stage 4: 4a retirement savings (10%), 4b pay off house (5%), save for your dreams (5%)
There are other parts of the book that I’ll skim over for brevity: That the rules of the money game have changed since your parent’s time (this was written in 2005), some very basic investment advice, “thinking traps”, relationships and money, home purchase, and when things get tough.
This is a very well-written, easy to read (for a financial book), book with good explanations and stories to illustrate the points. I highly recommend it.
So how does this apply to the FIREd population, particularly those using portfolio withdrawals for the majority of their expenses? I see three main directions [all of the following is IMHO, YMMY, IANAL nor a CFP]:
I’ll use a 4% inflation-adjusted SWR for these examples; substitute your preferred withdrawal strategy.
Notably, the authors don’t use the term ‘budget’ to describe their method; they say “balance” or “balanced money formula”. And this is not a traditional budget – there are three categories: Must-Haves, Wants, and Savings. The plan is to have those categories as 50%, 30%, and 20% of your take-home pay (after federal/state/municipal taxes, but before health insurance deductions and property taxes. Employer retirement plan or pension contributions are added to both take-home pay and savings.) Warren and Tyagi explain the reasons behind those percentages on pp. 26-33. 50% Must-Haves are sustainable, safe (for when things go financially wrong), and have been tested over time. The book is based on more than twenty years of intensive research (p. 4).
Must-Haves: A place to live, utilities, medical care, insurance, transportation, minimum payments on can’t escape legal obligations (for example, a cellular contract or child support), basic food. Credit card debt is handled under Savings.
Savings: Pretty obvious. After-tax savings, tax-advantaged savings, extra payments for mortgage/car loan/student loan. Subtract credit card debt.
Wants: Everything else!
There are easy worksheets for these and help columns for each. And examples of what spending too much on Must-Haves and too much on Wants look like.
There are two schools of thought on controlling spending: multiple frequent small leaks (the “Latte Factor”) and large expenditures (car, house, student debt). All Your Worth is firmly in the large expenditures camp. To bring spending in balance with their formula, they go through a series of steps, “Cut the Easy Stuff” (shop around for insurance costs), “Cut Where It Hurts a Little” (sell your car and buy used), and “Consider Radical Surgery” (a different job).
They talk about Wants, and are big supporters of cash and detractors of credit and debit cards.
The lifetime savings plan is nothing new or radical:
Stage 1: $1,000 emergency fund
Stage 2: Pay off “Steal-from-Tomorrow” debt (basically, everything except your mortgage/car loan/student loan(s))
Stage 3: Six-month emergency fund
Stage 4: 4a retirement savings (10%), 4b pay off house (5%), save for your dreams (5%)
There are other parts of the book that I’ll skim over for brevity: That the rules of the money game have changed since your parent’s time (this was written in 2005), some very basic investment advice, “thinking traps”, relationships and money, home purchase, and when things get tough.
This is a very well-written, easy to read (for a financial book), book with good explanations and stories to illustrate the points. I highly recommend it.
So how does this apply to the FIREd population, particularly those using portfolio withdrawals for the majority of their expenses? I see three main directions [all of the following is IMHO, YMMY, IANAL nor a CFP]:
I’ll use a 4% inflation-adjusted SWR for these examples; substitute your preferred withdrawal strategy.
- 2.0% / 1.2% / 0.8% Split the SWR into the categories; actually withdraw 3.2%, leaving the remainder to grow for long-term larger financial expenditures (boat?) and/or as a margin of safety for tough times.
- 2.0% / 2.0% / 0.0% Keep Must-Haves to 50% and spend the rest on Wants. This retains flexibility to cut if things go badly while allowing an immediate increase of 0.8% spending on Wants vs. method #1.
- 2.5% / 1.5% / 0.0% Allow Must-Haves to grow to 5/8 of total spend (maintaining the 50 / 30 ratio) and Wants to 3/8 of total spend. This allows more spending on things that can’t easily be cut (nicer house in better neighborhood?) at the expense of less flexibility to cut if things go badly.