Where It Goes

Jonathan Clements

WHEN FINANCIAL writers tackle the topic of spending, the result is all too predictable: lectures on the dangers of lattes, the glories of budgeting and the financial apocalypse engendered by avocado toast, as well as suggestions that earlier generations were far more prudent.

I’ll admit it, I haven’t entirely avoided these pitfalls.

So how should we think about spending? I would focus on how your income gets divvied up among four key categories:

1. Savings. Take however much you add to your employer’s retirement plan each month, and tack on any additional money you sock away. What’s that amount as a percentage of your pretax income?

If you’re still in the workforce, aim to save 12% to 15% of income toward retirement, though you might shoot for somewhat less if you’re eligible for a traditional pension plan or your employer makes matching contributions to your 401(k) or 403(b). What if you have other goals, like the kids’ college or a house down payment? You should be saving additional money, on top of the 12% to 15% for retirement.

2. Taxes. The taxman’s take varies enormously from one family to the next. But for what it’s worth, households lost an average 14% of adjusted gross income to federal income taxes in 2016, according to IRS figures.

Meanwhile, if you’re working, you’ll lose another 7.65% to Social Security and Medicare payroll taxes, and almost double that if you’re self-employed. What if you’re retired? Welcome to the big bonanza: Not only do you no longer need to save for retirement, but also you don’t have to cough up payroll taxes. Add those two together and your monthly outgoings might drop 20% or more—which is the reason it’s often said retirees need 80% or less of their preretirement income to live comfortably.

3. Fixed costs. As a rule of thumb, I often suggest that folks keep their fixed living costs—mortgage or rent, car payments, utilities, groceries, insurance premiums and so on—to 50% or less of pretax income. Those who are retired, and hence don’t have to worry about payroll taxes or saving for retirement, might aim to keep fixed costs to 60% of income.

That 50% or 60% is a tough goal to hit, but a worthy one. Why? You’ll have more financial wiggle room—and thus fewer money worries. If you’re still in the workforce, it will be easier to save and you’ll be in better shape if you find yourself out of work. You’ll also have more money to devote to our fourth and final category.

4. Discretionary spending. This is the stuff that helps make life special: vacations, eating out, concerts, amusement parks, gifts to family and charity. It’s the money we choose to spend, as opposed to our fixed costs, where we’re pretty much locked in.

A reader recently asked me how much was reasonable to spend on vacations. I’m not sure the amount much matters—as long as you’re saving enough, you aren’t racking up credit card debt and you feel you’re getting plenty of happiness from the dollars involved. For some folks, travel will be a big part of their discretionary spending, while others will have different priorities.

So what does financial happiness look like? Here’s today’s gross generalization: We should maximize savings, minimize taxes, minimize fixed costs and maximize discretionary spending.

To be sure, these generalizations come with all kinds of caveats. Sometimes, it makes sense to generate more taxable income, especially if we find ourselves in a year with relatively little income. Some families may opt for higher fixed costs, because they get great pleasure from owning a more expensive home or car. Some folks may be too focused on socking away money—though the national savings rate suggests this isn’t exactly a widespread problem.

Are you salting away enough money every month for your various goals? You should feel free to do whatever you want with the rest of your money, even if it involves copious quantities of lattes and avocado toast.

That brings us back to discretionary spending. I find it hard to imagine how you could have too many dollars stacked against this category. I’m not advocating that folks fritter away money on nonsense. But it’s a great pleasure to write a check to your favorite charity or head out to dinner with friends—and that’s especially true if you know you can easily afford the cost involved.

Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include Down the Drain and Great Debates. Jonathan’s latest books: From Here to Financial Happiness and How to Think About Money.

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