Three budgeting red flags
September 17, 2020
When meeting with clients to discuss their finances, budgets usually get brought up. I’m often asked, “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 the three biggest red flags I see in a budget that are a killer of financial wealth. There are other items, which I could write a whole book on, but I’ll stick to three for now.
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, liquid money markets (that are not tied to the market).
How much is suggested for an emergency fund? My recommendation is to have three to six months’ worth of core living expenses. Three months if you have a two-income earner house and six months if you have a one-income earner house.
To find out how much cash you have, here is the formula:
- Cash plus cash equivalents divided by monthly core expenses equals months of savings.
For those of us with less than the ideal amount, I would suggest starting with a smaller goal as three to six months’ can seem like a daunting number. However, when the smaller goal is met, set a little bigger goal and keep accumulating until the ideal savings is in place.
Housing Payment Costs
In most scenarios I see, the cost for housing is one of the largest expenses. When looking at this cost, be sure to also include property taxes and insurance costs.
- 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 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
When looking at total debt payments, we are looking at only debt and not normal monthly expenses, such as utilities to keep our house warm.
- All monthly debt payments plus PITI divided by gross monthly income should be equal to or less than 36 percent.
All monthly debt payments can include things such as car payments, credit card payments, store charge card, etc. My advice is to keep these debts and payments to a minimum as it can have a big impact on cash flow issues, especially when life happens and we need to come up with a little extra cash for said event.
I welcome your feedback in what works well or not well in your finances. Feel free to e-mail me at matt.riley@firstnbtc.com.
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