Automatic transfers: The best non-budgeting budgetThis easy approach, recommended by Jane Bryant Quinn, is one of the best I’ve seen and is genius in its simplicity: Automatically transfer a portion of your paycheck into savings and retirement accounts, and spend the rest as you wish. The process requires some up-front time, but once you’re set up, you can set money management on autopilot. There are three steps to automatic transfers:
- Identify your saving goals and must-pay expenses
- Figure out how much you need to save
- Set up the transfers themselves
Step one: Identify your saving goals and must-pay expensesDepending on your age and stage in life, you’ll have different saving goals. You should always be saving for retirement; however, younger people might be paying off debt while older workers might prioritize a down payment on a home or contributing to their kids’ education. You may also save for short-term goals, like a vacation or big purchase. You’ll also want to account for anything you absolutely must pay for – rent, student loan payments, insurance, a minimum amount of grocery expenses, etc. The first step to non-budget money management is to figure out what expenses you can’t get out of, and what goals you want to work towards.
Step two: Figure out how much you need to save to reach your goalsYou can calculate your must-pay expenses based on previous spending, but deciding how much you need to save is a bit more nebulous. There are two ways to go about it: Goal-based saving, or percentage-based saving.
Goal-based savingIf you have specific goals like a vacation or a child’s college tuition, you can back into how much you need to set aside every pay period knowing only how much you want to save and how long you have to do it (CalcXML has a good tool for this). Retirement is a little trickier, since you have to make assumptions about your spending habits, how long your savings will last, and the tax climate. SmartAsset allows you play with different scenarios and come up with a monthly savings amount based on your standard of living and risk tolerance.
Percentage-based savingIf you don’t want to deal with the variables associated with goal-based retirement saving, you can follow rules of thumb. Most personal finance experts recommend putting at least 15-20% of your paycheck aside for retirement, on top of your other savings or debt payoff goals. Saving a percentage of your paycheck makes computation easier, and often, your employer-based 401(k) will allow you to automatically contribute a set percentage.
Putting it all togetherHere’s an example. Let’s say you want to save $2,000 for next year’s vacation, have $75,000 set aside for when your daughter goes to college in 15 years, and plan to spend $65,000 annually once you retire in 40 years. Assuming that short-term savings (like your vacation fund) are put into zero-interest accounts, and long-term savings (tuition and retirement) are invested with a 7% annual return, your monthly saving goals are:
- $167 for vacation
- $415 for college tuition
- $519 for retirement (with a few assumptions on benefits, inflation, etc.)