How to set a budget: The 1/3 rule

It is hard to know exactly what you can or cannot afford before setting a budget. A budget will help manage your expenses to ensure enough money is left over each month to reach financial independence. The average US Savings rate is about 5%. At that rate it, would take someone without any savings about 65 years to retire. Yikes! Here is how the US saving rate compares to other countries:

Wow! I guess we should be happy the US is not dead last! Here are a few steps to set a basic budget.

Step 1

First, sign up for Mint or Personal Capital to track income and expenses. I personally use Mint and plan on doing a full review with sign up instructions as both websites are excellent.

Step 2

Next, calculate the after tax monthly income (Mint will display this number).

Step 3

Next, apply the 1/3 rule to budget each expense.

  • 1/3 – Rent or Mortgage
  • 1/3 – Everything Else! The largest expenses will likely be Food and Transportation.
  • 1/3 – Savings

Here is an example. Let’s say Bob’s monthly after tax income is $3500. His budget would be the following:

  • Rent or Mortgage: $1167
  • Transportation, Food, Clothing, Travel: $1167
  • Savings: $1167

If Bob follows this budget he can retire in 22 years. That is a lot less than 65 years!

This may be a bit of a reality check as your expenses may already exceed the budget like most people living in the US. There are two solutions: make more money or spend less. My suggestion would be to spend less (I will write a post explaining why). The three biggest expenses will likely be Housing, Transportation, and Food. Anything you can do to reduce these expenses will help greatly in increasing your savings. Getting a roommate, walking/biking to work, or cooking at home are all healthy for the body and the bank account.

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