Your Ideal Budget

Please note that all references to your salary refer to your after-tax salary.

Housing

When you first look for a place to live on your own, many apartments will require you to show proof of income.  This is so the landlord can determine if you will be able to pay the rent.  Most apartments will refuse to rent to anyone whose salary is less than twice the rent of the apartment.  When you apply for a mortgage, lenders like to see your monthly payment be no more than 1/3 of your take-home pay. 

In general, try to spend no more than 33% of your salary on total housing expenses.  Ideally this would be 25% (or less) on your rent or mortgage payment, and 5%-8% on electricity and water.  If you’re spending more than this, consider taking on a roommate or renting out extra storage space.  If you have a mortgage, consider refinancing the loan to reduce your interest rate.  Avoid refinancing solely to reduce the payment (unless you can no longer afford it).   

Transportation

A trap many young people fall into is spending too much of their salary on a car payment.  Remember, a car is a depreciating asset; you will very rarely be able to sell it for what you bought it for (not to mention maintenance costs).  No more than 10% of your salary should go towards your total transportation expense.  That includes your car payment, gas, maintenance, insurance and toll fees.

Very few people in their early 20s are able to meet this goal.  Higher insurance payments for men under 25 combined with the very low amount that many young people put down on a car loan make this a very hard goal to meet.  To try to meet it, shop around for auto insurance, and avoid sports cars or other vehicles that make your rates increase.  When shopping for a car, look for used models with good maintenance records and low gas mileage.  Try to finance as little of the purchase as possible, and avoid trading in the vehicle until it is paid off.

Credit Cards

Ideally, you should never carry a balance on high interest credit card debt.  When you’re first starting off, however, these cards can be a good tool if an emergency comes up.  Of course, you should work towards creating an emergency fund, but in the meantime work on controlling and eliminating your credit card debt.  Lenders like to see no more than 45% of your net salary going towards paying off the minimums on all your debt.  That includes your car, mortgage, student loans and all of your credit cards.  Assuming that your car payment is 10% of your net and your mortgage is 25% (even if you don’t have a mortgage right now your ideal budget should be built around the idea that you will have one someday), no more than 10% of your net salary should go towards the minimums on your credit cards. 

Please note that this is a guideline for the minimums on your cards.  Of course, it is a good idea to pay more than the minimums when the cards have high interest rates.  If the minimum payments on your cards exceed 10% of your net salary, do everything you can to pay them off as quickly as possible.

Savings

With 55% of your net salary spoken for in the above categories, you might be surprised that many financial planners would like you to save at least 40% of your salary; and many more recommend saving at least 60% (for you math wizards out there, these planners are usually talking to older audiences who have paid off their houses, cars, and credit cards).  When you’re just starting out, though, you can set your goals a little lower.  Aim to save 30% of your salary, with 10% going towards an emergency fund, 10% going towards mid-range goals (returning to college, a down payment for a house, etc.), and 10% going towards retirement.

Your emergency fund is one of the most important financial tools you can have.  Putting money aside for car repairs, insurance deductibles, or plane tickets back home in case of a family emergency will prevent you from using credit cards (and paying the resulting high interest rates).  Currently, many financial experts say you should have at least eight months of your living expenses saved.  Your living expenses include all of your necessary bills (rent, utilities, and debt payments) plus any additional money needed for transportation and food.  In general, you can assume that during a job loss, you will suspend additional saving.  Therefore, if you are following this plan your monthly expenses are probably around 70% of your net salary.  If you are saving at 10% a month, it will take you about 56 months (almost 5 years) to save this amount of money.  And that assumes you don’t have an emergency during that time.

A lot young people look at this goal and decide that they could never do it.  Realize, however that it will take a while to reach this sum, but in the meantime you will have some amount set aside to deal with the unexpected.  An amount as low as $500 can pay for a small car repair, a domestic plane ticket, or the deductible on your renter’s insurance.  For now, put 10% aside every month to get started on your cushion.

Retirement savings are something very few people in their 20s think about.  Consider, however, that a 25 year old woman today in the United States has a life expectancy of 88 years.  Assuming she retires at 67, she will have to pay for 21 years of living expenses.  Think of the example above and you realize the key to having enough money to retire is to start early. 

Following these guidelines can give you a good start on a budget and managing your expenses.   Once you have created and lived within a budget for a few months, you can move on to learning more about investments.