Three budgeting red flags
September 17, 2020
When clients meet with financial advisors to discuss their finances, the topic of budgets typically arises. They often inquire, “Am I doing anything glaringly wrong?” It’s a fair question and we all have these thoughts at some point in our life. “Are we doing better than, equal to or worse than the average?”
Here are three big red flags in a budget that are a killer of financial wealth.
Emergency Fund
The first red flag is not having an emergency fund or using the wrong assets for an emergency fund. The purpose of an emergency fund is to have quick access to cash in the event of an emergency. The only things that should be used for an emergency funds are cash or cash equivalents, savings accounts and liquid money markets (that are not tied to the market).
How much is suggested for an emergency fund? It's recommended to have 3-6 months' worth of core living expenses in an emergency fund. For households with dual incomes, three months' worth is advised, while single-income households should aim for six months.
To calculate available cash, use the following formula:
- (Cash + cash equivalents) divided by monthly core expenses = months of savings.
For those with less than the ideal amount, setting smaller goals initially is more achievable. As each goal is achieved, gradually increase it until the desired savings level is reached.
Housing Payment Costs
Housing expenses typically represent one of the largest budget items. When assessing this cost, it's essential to include property taxes and insurance expenses.
- PITI (Principal, Interest, Property Taxes, and Home Owners Insurance) divided by monthly gross income should be equal to or less than 28 percent.
This can be a big red flag for those of us who go above the 28 percent. Remember that we want this number to be less than or equal to 28 percent but NOT greater than. If we get greater than 28 percent, we are sacrificing other areas of our financial life such as savings towards retirement or some future goal.
Total Debt Payment
Evaluating total debt payments involves considering debt alone, excluding regular monthly expenses like utilities.
- All monthly debt payments plus PITI divided by gross monthly income should be equal to or less than 36 percent.
Minimizing debt and its associated payments is recommended to alleviate potential cash flow challenges, especially in unforeseen circumstances that demand extra funds.
Whether your budget is solid or maybe needs some tweaking, the professionals at First National Bank and Trust Company can create a customized plan to ensure that sticking to your budget will continue through retirement. To begin discussing your future financial plan, please call 217-935-7456 or fill out the form below to schedule an appointment.
About First National Bank and Trust Company: First National Bank & Trust Company is a community bank located in Clinton, Illinois. Dedicated to community prosperity, the bank was chartered in 1872 under the name DeWitt County National Bank. The name was changed First National Bank and Trust Company in 1974, and was acquired by TS Banking Group in 2017. With $181 million in assets, First National Bank is dedicated to community reinvestment and gives 10% of its net income back to the community. For more information visit firstnbtc.com