How Much Can You Spend?
It can be really challenging to know how much you can spend without blowing your budget. The best place to start is figuring out exactly how much income you have. Once you know both your gross and net income, you can calculate how much discretionary – available funds – you have to spend.
Gross versus Net income
Your gross income includes any compensation you receive from wages, bonuses, commissions, profits, interest, rents or any other form of earnings, before any taxes or deductions. This impacts how much you can contribute to a retirement plan, your income tax rate and whether you qualify for credits or deductions. Lenders use this figure to calculate how much you can spend on loan payments.
Your net income is the available income after taxes and deductions. Employers will deduct this for you. Your paycheck is your net income. If you receive income from other sources, your accountant should help you calculate how much to set aside for taxes and Social Security.
If you are self-employed, receive rental income or own a business, take time to identify what your gross income needs to be for future lending needs. Lenders look at tax returns and pay stubs.
How much do you spend now?
Now that you know how much income you make, the next step is to figure out where your income is going. The best place to start is by reviewing your actual spending for the year. Create a worksheet. Divide it into different categories to better reflect the purpose for each item, such as “Housing” or “Travel”. Work your way through every account, every bill, every automatic payment and add it up. Make a note of any special events that don’t happen very often. Once you have a total for each category, divide that amount by the number of months you reviewed.This will give you an average monthly amount for each category.
Next, let’s take a closer look at your spending. First, identify any spending that is related to your living expenses. Calculate your Living Expense Ratio:
Your living expenses are usually fixed and recurring every month. These are obligations that need to be paid, otherwise you will be charged fees, fines or collections. To reduce financial stress, keep your Living Expense Ratio below 70% of your net income. Either increase your income or reduce your expenses to stay below that limit.
Spend with confidence
Once you take control of your living expenses, you’ll know exactly how much discretionary funds you have available to spend. Here are some helpful guidelines to keep in mind:
- Keep your housing expenses below 30% of your gross income
- Reduce your total monthly debt payments to 40% or less; include your Rent/House payment
- Create clear goals for how you want to spend/invest your available funds
- Build up your reserves – at least 3 to 6 months of living expenses
- Set aside 10% or more towards your retirement funds – start with whatever you can
- Create separate savings buckets for travel, holiday/gifts and self-care
Invest time in your financial health
If you don’t take control of your financial health, the stress and anxiety will only get worse. Now is a great time to review your finances and create a plan for a better future. Start with our free Financial Health Assessment. Next, schedule a complimentary Financial Coaching session. Let us know what’s on your mind, what’s keeping you up at night. We’re here to help you build a life you love.