Australian millionaire property developer Tim Gurner hit a raw nerve earlier this year when he said young people couldn’t afford to buy a home because they were spending too much on avocado toast.
The suggestion – rooted in the notion that if you look after the cents, the dollars will look after themselves – seemed out of touch with the reality of Australian house prices, but it also implied that saving simply requires depriving yourself of life’s little luxuries.
That approach to budgeting is no fun and rarely works in the long term. So what’s the alternative?
US Senator Elizabeth Warren, and daughter Amelia Warren Tyagi believe they have the answer.
In their book, All Your Worth: The Ultimate Lifetime Money Plan, the pair set out a system of budgeting they say can be sustainably applied over a lifetime.
They advocate dividing net pay three ways:
- 50 per cent to the must-haves
- 30 per cent to wants
- 20 per cent to savings.
They set out practical steps for achieving the split: shop around for a cheaper home loan, try to negotiate lower rent, and look for better deals on insurance, childcare and other major items, they suggest. If that’s not enough to get expenses under control, they prescribe radical action such as taking a second job or moving to cheaper housing.
Basically, you re-engineer your situation so no more than 50 per cent of your income goes to your must-haves, 20 per cent can go to savings and 30 per cent to your wants. Over a lifetime such a disciplined approach to money should put people in a strong financial situation.
Add some flexibility to your budget
Laura Higgins, senior executive leader, financial capability, at the Australian Securities and Investments Commission, says it’s useful to frame budgeting in terms of needs, wants and savings but warns a 50-30-20 split may not suit everyone.
“If this doesn’t work for you, don’t get discouraged,” says Higgins, who runs ASIC’s MoneySmart website. “Any time you’re talking about needs, wants and savings you’re on the right track.”
Budget must-haves include regular monthly expenses that cannot be avoided, such as mortgage or rent payments, healthcare costs, child support, and payments on long-term (legally binding) contracts.
Everything else – aside from savings – goes in the wants category. In their book, Warren and Warren Tyagi, even consider food beyond a basic meal prepared at home to be an indulgence.
By these definitions, a university student working part-time may easily spend more than half their income on the basics. A family with a mortgage, childcare expenses, and transport costs may also struggle to keep must-haves to 50 per cent of take-home pay.
“In a big city the costs add up very quickly,” Higgins says.
The authors acknowledge there will be times when it’s impossible to achieve the 50-30-20 split they describe – such as the arrival of a new baby, job loss, illness, or starting a business. But they argue these events are temporary and the split they suggest is achievable and sustainable for everyone.
Constantly review and revise your budget
A budget should be able to accommodate changing circumstances or unexpected events, Higgins says.
“When you hit those bumps along the way it’s time to do a health check, revisit the long-term financial plan and make sure it’s relevant to your current circumstances,” she says.
“You need to keep checking in with your goals and bigger plan. Having a day-to-day budget is one thing but it needs to sit beside an overall, long-term plan.”
Even when everything is running smoothly, you should review your budget annually to make sure it is still appropriate, says Adrian Raftery. The associate professor at Deakin Business School and author is a certified financial planner who goes by the moniker Mr Taxman.
Raftery says a straightforward approach like that described by Warren and Warren Tyagi might suit people who are living pay-cheque-to-pay-cheque and those with a history of credit-card debt, but some people may find it useful to go into more detail.
“Three categories are better than none, but if you want to get more sophisticated you would have more than three,” Raftery says.
Savings, for example, could be split into funds set aside for the short-medium- and long-term.
Short-term savings could cover day-to-day expenses in an emergency. Medium-term funds might be building a deposit for a property, and long-term savings would include superannuation and a home.
Raftery says most people should prioritise savings and consider allocating more than 20 per cent of their income to that area. Compulsory superannuation contributions should be saved in addition to this amount, he says.
Deal with credit-card debt
In their book, Warren and Warren Tyagi include repaying credit-card debt, including the minimum monthly payment, in the savings category.
Raftery disagrees, preferring to consider it a must-have.
“Credit card debt is the result of your budget not being satisfied,” he says. “You have spent more than you have in the bank and used credit cards to supplement the lifestyle choices you’ve made. If you do have a credit card debt it means you have got it wrong in the past. You need to clear that debt before you go on because it is going to stymie your efforts in future.”