How Not To Prioritize Your Financial Goals

March 13, 2014

In this article, Learnvest provides some guidelines as to how to budget and prioritize your financial goals. First, when it comes to budgeting, they suggest what they call the 50/20/30 rule:

  • “No more than 50% of your take-home pay should be spent on Essential Expenses, which are strictly defined as your housing, transportation, utilities and groceries. Nothing else.
  • At least 20% of your take-home pay should go to Financial Priorities, which are defined as retirement contributions, savings contributions and debt payments. And we’re not counting any retirement contributions you make through your employer, such as a 401(k) or a 403(b).
  • Lastly, no more than 30% of your take-home pay should go toward your Lifestyle Choices, which encompasses everything else: shopping, the babysitter, entertainment, personal care, the gym, cable, gifts, your cell phone, dog food, and more.

The problem with budgeting guidelines like this is that everyone’s situation, goals, and priorities are so different. For example, I know people who choose to spend less on housing so they can spend more on travel. They may be spending more than 30% of their take-home pay on “lifestyle choices” but is that really a problem? (Not according to research on how spending money makes us happy.)

Vice-versa, I know people who spend more than 50% of their income on “essential expenses” because they live in an expensive area like NYC or San Francisco but they compensate by spending less on “lifestyle choices” like shopping and entertainment. Neither approach is right or wrong. The important thing is that your budget is sustainable and matches what’s important to you, not someone else’s arbitrary set of numbers.

However, there are rules of thumb that can be useful to help people with their financial planning. Unfortunately, the article doesn’t do much better here either. They suggest prioritizing retirement savings first, emergency savings second, and paying down debt third.

That order puts the urgent priority of emergency savings behind the less urgent (but just as important goal) of saving for retirement. The problem with this is that an emergency can happen anytime. What happens if you’re funding your 401(k) and need emergency money tomorrow?  At best, you might be able to borrow up to half of your 401(k) account but that has to be paid back within a relatively short period of time. At worst, not being able to pay your mortgage can cost you your home. Now, given the state of retirement saving in America, I can understand wanting to put it first. But if your emergency savings goal is $10k, that $10k is not going to make or break your retirement.

The article even recognizes the problems in its priorities by describing 5 scenarios that could be exceptions. They suggest that “if you fit one of these profiles, you might want to see a Certified Financial Planner® to get appropriate advice for you. (We do sell such plans through LearnVest Planning Services.)” For what I would recommend instead, check out my recent piece on this topic in Forbes here.