Why Template Budgets Set You up for Financial Failure
But adding one additional step can fix the problem
I recently typed “budgeting rule” into Google, and every article on the first page recommended the same budget template; the 50/30/20 rule.
According to the 50/30/20 rule, here’s how you spend your money:
50% on needs—necessities like housing and groceries
30% on wants—variable spending like on entertainment and travel
20% goes to savings.
Like with every rule of thumb, the 50/30/20 rule simplifies a complex issue—in this case, how to spend your money. But as I’ve written in the past, simplifying a complex issue means leaving out the complicated details. We all know the saying, “The devil is in the details.”
In this edition of Money on my Mind, I explain why the details left out in generic budget templates, like the 50/30/20 rule, will likely cause you to underestimate how much money you’ll spend, leaving you with less savings than you budgeted.
The sneaky expenses you probably left out of your budget
A 2012 study identified why so many generic budgets fall apart when used in real life:
We vastly underestimate how often and how much we spend money on “one time” purchases that aren’t accounted for in our budget.
The paper's opening paragraph gives some concrete examples of spending that we tell ourselves is rare and worth splurging on.
Your favorite musician is in town for one night only, and tickets are $1,500. So, you buy two tickets even though your monthly entertainment budget is $250.
Next month is tour 1st/5th/10th/20th/25th/50th wedding anniversary, and you and your spouse want to celebrate with a 5-star vacation that costs three years’ worth of budgeted spending on travel.
Your phone dies—or, more likely, is just out of date—and you need to spend $750 to buy a new one. The problem? You budget $100 monthly for your cell phone bill but don’t include the cost of replacing that phone every two years.
Your inlaws are staying at your house for a week over the holidays, so you need to stock up on additional groceries and alcohol.
You tell yourself that these are all “exceptional circumstances,” so even though you haven’t budgeted for these expensive events, it’s okay because “you’re not going to make a habit of it.”
Except, you are going to make a habit of it.
While it may be true that any one of these expenses is unlikely to repeat itself anytime soon, there is always another exceptional circumstance that will require you to spend more money.
That’s just life. Random events are always happening that don’t fit neatly into a generic budget template.
Underestimating your spending = overestimating your savings
If your income is relatively stable from month to month, then money is a zero-sum game; every dollar you spend above your budget is a dollar that does not get saved or invested.
If you base your financial plan around the 50/30/20 budget, your financial future relies on the idea that you will save and invest 20% of your income, which is easy enough to do on paper.
But when we fail to budget for these exceptional expenses—the $750 to buy a new phone—that money has to come from somewhere. It might mean cutting back on spending in other areas, but let’s be honest; it often means saving less money.
What happens if your budget allocates 20% of your income to saving, but after paying for various “one-off” expenses throughout the year, you only save 10%?
For a 30-year-old, clearing $50,000 per year after taxes, that adds up to $367,671 less money saved by the time they are 65—assuming only a 4% average return on their savings and investments. The higher you assume your return on savings/investments, the greater the shortfall in final expected savings.
Why does it matter?
Saving less than half of what you planned for means delaying retirement, working part-time in retirement, reducing your standard of living in retirement—or some combination of these three options.
Let’s talk about how to fix this problem and more accurately forecast how much money you’ll spend each year.