How to Allocate Your Income

“How much should we be saving?”  A question we hear quite often. The fact is, nobody knows the perfect answer.  I don’t know, you don’t know, and the world wide web doesn’t know.  

However, what we do have are guidelines to help steer us all in a more informed direction.  In this blog, I will share with you my recommendation when it comes to allocating your income into three categories: saving, giving, and everything else.

Please note, these percentages are based off of your gross income.  So when your employer says you will make $120,000 this year – that’s the figure I’m referring to.  Not your actual take home pay after deductions and tax withholdings. That figure is your net income.

SAVING – 20% 

I’m not the first to suggest this, and I will not be the last.  Saving 20% of your gross income is ideal. But, where does this figure come from? Let’s uncover the details below.  

**viewer discretion advised, lots of numbers ahead**

Pundits believe that upon retirement the annual amount you should withdraw from your entire retirement bucket should be ~4% of the total value.  Therefore, if you saved $2,000,000 upon retirement, your total gross distribution should be $80,000. Another way of calculating this is figuring out your gross expense need ($80,000) and multiplying it by 25 to give you the amount you’ll need at retirement ($2,000,000).

Now I’ll show you how we get to 20% with all this.  That multiple of 25x your distribution need is then utilized to come up with your savings rate and time horizon.  Assuming an average rate of return of 5%, and a savings rate of 20%, it will take you approximately 41 years to come up with 25x your distribution need.  Therefore, if you start saving by the time you are 25, you’ll be 66 by the time your portfolio is 25 times that of your expense need.  

See?  There is a reason behind the madness.  

Of course there are various aspects that come into play here.  If your employer contributes to your retirement savings as well, that counts towards the 20% goal.  Or, maybe you started saving at age 30. If you saved 20% and your employer contributed 5% (25% total) it will take you 37 years to get to 25x your distribution need (assuming a 5% average rate of return).  You’d be 67 by the time you reach financial independence (only one year later than the example above).

GIVING – 10%

As discussed in a previous blog I wrote, giving gives us joy, and lots of it.  Giving to charities or nonprofits helps support missions and values important to you in ways that enhance your own capabilities.  Think about the largest obstacles facing our us and earth today that concern you. I bet you can also think of at least one or two charitable or nonprofit organizations hoping to tackle that problem.  They are in need of your support to assist in these issues you’re both so very passionate about.  

In the book, Happy Money: The Science of Happier Spending (2013), Professors Elizabeth Dunn & Michael Norton found individuals that spent $5 on someone else reported being more happy than those that spent up to $20 on themselves.  Their findings tell us that it is more important how you spend your money than what you spend your money on when achieving financial satisfaction.

Giving 10% of your income can feel like a pretty large chunk, especially for those who aren’t currently allocating their dollars this way.  Therefore, consider giving an amount that makes sense for you. You may also try gifting your time (say…10%?), or consider starting at 2% and working your way up to an amount that fits your needs.

EVERYTHING ELSE – 70%

Yes, I could break this out even more, and I will to an extent.  However, I tend to carry the belief that your money is just that – yours.  How you decide to allocate it here is entirely up to your needs and situation.  

One area that I will provide some specifics around are your housing and debt expenses.  According to the CFP Board (CERTIFIED FINANCIAL PLANNER™), they recommend no more than 28% of your gross income allocated towards rent or home payments (including principle, interest, taxes, and insurance).  

Debt associated with items outside of your shelter (such as your car, school loans, credit card, etc.) should equal no more than 8%.  If you do the math (don’t worry – I got you) that’s 36% total in debt payments; 28% for housing, and 8% for other debt.  

All my millennials out there are like… ‘Who came up with that?  ‘Cause my student loan payment is way more than that.’  I hear ya!!  I have a friend who started making $120,000 out of grad school.  However, her student loans were setting her back about $1,200/month.  That means her student loan payments were ~12% of her gross income. SHE IS NEVER GOING TO MAKE IT AND IS DOOMED FOR LIFE!!

Just kidding.  This is where adaptation comes into play.  Focus more so on that 36% figure. With my friend, her annual debt payments should not exceed $43,200 (36% of $120,000).  If her student loan payments soak up $14,400/year that leaves $28,800/year leftover for rent and other debt payments. If her only debt is student loans, that still leaves $2,400/month she could allocate towards rent.  That’s plenty for where she lives. Her monthly rent is actually less than $1,000/month which means her debt to income ratio is closer to 22%.  

LET’S PUT IT ALL TOGETHER

Income	$120,000/yr.
Taxes (assuming a 16% effective tax rate)	$19,200/yr.
Gifting (assuming 10%)	$12,000/yr.
Saving (assuming 20%)	$24,000/yr.
Equals Take Home Pay	$64,800/yr.
Total Debt (assuming 36%)	$43,200/yr.
Everything Else	$21,600/yr. ($1,800/mo)

If my friend were to soak up her entire 36% debt ratio figure, she would have $1,800 left to spend on groceries, clothes, gas, restaurants, and so on.  Her actual debt payments are $26,400 leaving her with $38,400/year ($3,200/mo) for everything else.

My 20/10/70 recommendation for how to allocate your income is for a broad audience.  Your situation is unique, and therefore, your allocation should be too. Utilize this blog like you would with bumpers at the bowling lane.  Ultimately where you strike the pins depends on how you throw it (can you tell I’m not a bowler?). Apps like Honeyfi make finding your allocation easier than ever.  Utilize their ‘Goals’ feature to help assist your specific situation further to determine where you are and where you want to go.

Written by: Natalie Slagle, CFP® with Fyooz Financial Planning