In simple terms, you want to earn more money than you spend. As long as you do this, you’ll never have to dip into your savings to make ends meet. However, this mindset can lead you down the wrong path. You must know how you allocate your income, as that gives you a clear view of what you’re doing right and what you’re doing wrong.
Generally speaking, there are two categories for allocating your income:
- Spending: The money in this category is used for monthly expenses such as housing, food, utilities, and entertainment among others.
- Saving: The money in this category is assigned to savings accounts, retirement accounts, and various investments.
How you allocate your income within each category depends on factors such as how much you earn, the total of your monthly expenses, and your savings strategy.
Let’s take a closer look at these three factors:
- Income: As an employee, you know how much money you’ll earn every month as well as when you’ll receive it. This number may change, based on factors such as bonuses or additional withholdings, but you’ll typically know what you’re receiving each month.
- Expenses: This is where your monthly budget comes into play. It outlines every expense and how much you can expect to pay for it. It’s critical that you review and update your budget as necessary. For instance, your car payment may change at some point if you trade in your current vehicle for a new one.
- Savings: There’s no shortage of ways to save money. You can do so in a savings account. You can stock away as much as possible for retirement. You can invest in stocks and bonds. You can buy real estate. Your goal is to save as much money as possible.
The manner in which you allocate your income has the potential to change over time. If possible, you want to reduce your expenses and boost your savings. This puts you in a much better overall financial position.
On paper, all of this sounds simple but you’re likely to run into challenges along the way. Some of the things to watch out for include:
- Spending more money than you earn
- Allocating your savings to the wrong types of accounts
- Stagnant income (or even a pay cut)
On the plus side, these types of challenges can be overcome with the right approach. Advanced planning allows you to manage anything that comes your way.
What is your particular strategy for allocating your income? Has this strategy always worked for you, or have you been forced to make adjustments over the years?