Don’t let 2019 be another year of frivolously spending money and taking on new debt. Spending may be fun at the moment, but the flash of excitement will quickly fade. Debt and financial insecurity has been linked to increased stress, anxiety, weight gain, and hypertension. Plus, the more debt you take on now, the less buying power you’ll have for big-ticket items like a home, vacations, new vehicles, or appliances.
Credit card debt, student loan debt, and medical bills are at an all-time high in the United States. While there is plenty that can (and should) be said about the social structures that encourage indebtedness in these areas, collective action and legislation are long-game processes. What you can do today on an individual level is work on bulletproofing your finances and learning to live in a way that it is resistant to debt and over-spending.
To do this, I recommend a two-pronged approach: sticking to a 50-30-20 budget and snowballing your debts away. Here’s what that means.
Budgeting the 50-30-20 Way
If you passed elementary school math, you’ve probably done a little bit of quick mental math and added together 50+30+20. In case you’re still digging for your calculators, it adds up to 100.
The 50-30-20 budget is a way of thinking about how your finances should be allocated on a monthly basis.
- 50% of your income should be allocated for your fixed monthly expenses (think rent, mortgage, bills, and groceries).
- 30% of your income is for elective spending (this encompasses everything from eating out to entertainment).
- 20% of your income should go into savings and paying off debt.
As we’ve written before, in order to get started with a 50-30-20 budget, it’s important to start by calculating your net income. For example, if you have an annual salary of $35,000, this doesn’t mean that you’re going to have $17,500 each year to put toward your fixed expenses. After taxes and deductions, it’s probably going to come out closer to an annual income of $24,500 with $12,250 being able to be put toward fixed expenses.
Being realistic about your actual annual income is absolutely necessary so that you can carefully calculate what your spending targets should be. Note that I referred to them as targets. Starting off, most people are not going to be in a place where they’re able to easily commit to a 50-30-20 spread. That’s okay. Don’t let this be a deterrent to getting started.
You need to put your budget into writing so that you can clearly track your spending and your financial goals.
Start by calculating your actualized income and then adding up all of your fixed monthly expenses. Use the last six months to calculate an average if you know that you deal with a little bit of variation from month to month.
Subtract your fixed expenses from your net income. The remaining amount of money will then need to be split between your elective spending and your savings/ debt payment. Eventually, you’re going to want to get these categories close to the target 30% and 20% of your income respectively. But, when you’re just getting started, the size of your current fixed expenses and your amount of debt may make that an impossibility.
If there’s a category that you can compromise on and devote a smaller percentage to, it’s elective spending. This may mean missing out on some of your wants in the short term, but trust me– it’s worth it in the long term. Your fixed expenses typically don’t have any wiggle room unless you cut off or downgrade somewhere– such as taking in a roommate to split your rent or cutting our cable. It may be tempting to try to cut back on the amount that you’re saving and putting towards paying off debt, but this is a huge no-no. Paying off your debt as quickly as possible is your key to building long-term wealth.
Snowballing Your Debt
Let’s say you currently have $1,500 in credit card debt between two credit cards and $25,000 in student loans to repay. Your credit cards both have a minimum monthly payment of $25 and your student loan requires $280 per month. If we stick with the $35,000 gross annual income scenario with approximately $24,000 in net annual income, our 20% to put towards savings and debt would come out to $4,800 per year or about $400 per month.
The combined minimum payments for the credit card and the student loans is $335 dollars per month, so the good news is that this amount fits within our 20%. But, keep in mind that that $335 represents your minimum payments. While you can pay off debts this way over time, you’re going to be paying a lot more over time because your payments are primarily covering your interest rather than the principal amount of your debts.
It may be tempting to think that since you’ve got $65 left within your monthly savings and debt fund, you should put that toward your student loan since it’s the bigger amount. While that may help you to an extent, it’s not the smartest way to use your money.
Instead, I would recommend putting $25 into savings and putting an extra $40 toward your credit card debts each month. Credit cards typically have a much higher interest rate than student loans, so the longer they stretch out, the more you’re going to be paying. So, with this, you’re going to be paying $65 per month for your credit cards and $280 for your student loans.
At the end of each month, if you have any money left over in your elective spending category, I advise splitting it evenly between savings and paying off your credit card. Along the way, do not take on any more credit card debt– to put things into perspective, if your credit card has an interest rate of about 16%, it’ll currently take you 29 months to pay it off, and you’ll be paying over $300 in interest alone. If you keep putting more and more on your credit card, that number is only going to be higher.
At the end of those 29 months, however, you’ll be free from your credit card debt! If you’re not careful, there are two huge mistakes you could make:
- You could take on credit card debt again by not sticking to a 30% maximum for your elective spending, or
- You now look at your budget and decide that since your credit cards are paid off, you have $65 more dollars to allocate elsewhere.
Instead, snowballing your debts means that you now take that $65 you’ve been paying towards your credit cards and roll it into your student loan payments. $65 may not feel like that much money in comparison to what you’re already spending on student loans each month, but since you’re already paying the minimum payment, that $65 goes toward the principal loan amount, not the interest. Paying against the principal as much as possible is the fastest way to shorten the lifespan of your debt and, since you’ll have less interest to pay, you’ll minimize the amount that you’ll be paying toward your loan overall.
Money Changes Everything
As Cyndi Lauper once sang, money changes everything. The more you budget and pay off your debts, the more doors you’ll open up for yourself. Paying off your debts will help to improve your credit score, which can make the difference between getting approved or denied for a mortgage; it could mean building up your savings enough to be able to pay for an overseas vacation without having to take on debt.