Your Financial Makeover, Step #2: Budgeting and Saving

Ramit Sethi

Ok, let’s do this. This is part 2 of the 2006 financial makeover (see step 1), where you take control of your money. By the time we’re done, you’ll have 2 things:

1. An infrastructure of budgeting and saving. This will let you make conscious decisions about your money, rather than opening your statements at the end of the month and shrugging, “Well, I guess I did spend that much.”
2. Better personal-finance knowledge than 99% of your peers, whom you can disparagingly scoff at as you sit in your golden throne. I do this daily.

Now, judging from the emails and comments I got last week, lots of people had a great time debating the ~0.5% differences among ING vs. HSBC vs. Emigrant Direct savings account. Fun, huh!!! However, fewer people–like, fewer than 5–wrote to ask specific budgeting questions.

Like I said before, this is a personal-finance ass-kicking, not a Willy Wonka lovefest. We are going back to basics. For those of you who did everything last week, don’t worry: I have new things for you to do today. For the 82395923 people who want to know where they should invest, be patient. It would be irresponsible for me to start talking about investing without providing a foundation to support it.

Complete your budget
In step 1 of this makeover, I wrote about making a budget to track your last 4-6 weeks of income/spending. There are 2 ways to do a budget: Top-down (where you write down what you should spend) and bottom-up (where you write down what you did spend). A top-down budget is better: It’s predictive and lets you set goals to achieve. But to get there, you have to start with a bottom-up budget and notice exactly what you’re spending money on.

So let’s get on with it.

Thanks to everyone who sent me sample Excel spreadsheets last week. Here are the best 2: Budget spreadsheet 1& Budget spreadsheet 2. (Thanks to Wayne and Kiran; FYI the 1st spreadsheet is from the MS Office template page).

You’ll notice that I’m not doing a sample budget or pre-filling in values. That’s intentional. Budgets are (1) hard and (2) individual for each situation. And once someone spends the time making one, they’re much more committed to actually using it.

Now, here’s what I want:

1. Make a budget. If you didn’t do this last week, do it now. Remember, don’t be limited by the categories. Add/remove as necessary.
2. Factor in irregular events. Budget in spending for Christmas gifts, friends’/family members’ birthdays, vacation (airfare, hotel, spending, etc), vehicle registration, etc.

Two notes here: First, these irregular events represent a lot of money. Spend some time and write down accurate numbers, because you’re going to use this budget as a guide for all future spending. Second, if you can’t put an exact number down, be generous with your estimates. If you budget $10 for your parents’ 25th-anniversary gift, then you are a moron and your budget is not going to work. Better to overestimate than to underestimate.

Start thinking about how much to save
In the last quarter of 2005, for every dollar earned, Americans saved exactly zero. Even more astonishingly, they spent more than they made. (For context, China’s savings rate is about 40%.)

Don’t be that guy. Most personal-finance books recommend saving 10% of your income as a minimum. I agree–that is a bare minimum. Barring any extraordinary circumstances, if you’re single and have an income, I urge you to save 20-30% at a minimum.

Here’s why you should save more right now: At our age, each dollar we put away now is worth much more than a dollar we save at age 35. Yes, we could buy some new jeans right now, but by saving more right now, we’re actually giving ourselves more money later–much more.

Second, it never gets easier than right now. You’re single and earning, say, $50,000. You don’t have any kids or a mortgage. All you have to spend on is yourself. Just think about this for a second. Try to imagine yourself 10 years from now: How much is that annual vacation you have to go on? How much are diapers for your kids every week? What about toys? Or car insurance for your 16-year old son?

It might seem like I hate kids, but I don’t. Let’s keep it real: They’re expensive, and so are the multiple cars you’ll have, the home insurance, and everything else. That’s why starting now gives you a huge cushion to maintain your lifestyle when your costs rise.

It never gets easier than right now. What % of your income should you save? I can’t give you a number, but I can tell you this: Figure out what you can comfortably save, then save much more than that.

All my money is in one place. Now what?
Ok, here’s the deal. You need to do 2 things:

1. Create a system to manage all future income/spending
2. Figure out how to allocate your money

First, let’s do the system. Read how I set up my financial accounts. You’ll notice that I use my checking account like my email inbox: Everything goes there first, then I disburse it to the right place.

Another way is to tell your employer to automatically deduct a certain amount of money from each paycheck and send it to a certain account. (Ask your HR department.) For example, you might withdraw $300 from each paycheck, send it to ING, and have ING automatically send $500/month to your ETrade account. Automatic deduction is another great way to consistently save.

Second, you’ll want to distinguish between money you want to invest (long term) and money you want to save for a short- to mid-term horizon; your savings would be used for things like buying a car, going on vacation, buying a house, etc.

A final thought: Here is one of the best simulations for why starting to save earlier pays off unbelievably well.

Next week: Your system is in place and we start on investing. We’ll go over different asset classes (stocks, bonds, etc) and you’ll open an investment account.

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  1. Mike Willingham

    I recently signed up to do my budgeting and expense tracking through It is Christian based; however, during my research I found it to be one of the best. Hope this helps. Thanks Ramit – you’re giving helpful information.

  2. Ravi Char

    Ramit – You are incredibly smart. I wish I had a wife who was as smart as you and did this for me 😉

    Thanks for this great series on personal finance.

  3. Dan

    This is very good. The idea of saving 10% is excellent.

    However the problem is what to do with the money. As an US person you have a lot of opportunities to invest.

    However, I live in Romania. Here mutual funds are just a way for charismatic people to raise a lot of money, pretend that they invest and then to run away with the money. This happened with a fund called FNI. So.. investing in a fund is a high risk investment.

  4. Chris Yeh

    Believe Ramit when he talks about kids. I spend about $70K per year on my two kids, ranging from $35K for day care to an extra $15K for having to rent a bigger place, to God knows how much for toys, birthdays, and everything else.

    Save now!

  5. badplaid

    Best website ever for keeping track of a ton of various financial accounts…why everone in the world doesnt use it, i will never know.

  6. Dan

    You mention there are three essential topics for budgeting: regular events, irregular events and savings. Since regular events are pretty well defined and you get to pick savings, can’t you designate what is left as irregular events? That way, instead of saying, “Well, I guess I would be happy having $30 to spend on clothes each month.” you could say “I have $300 to spend this month if I want to, should I buy clothes with it or short term savings for a new HDTV.”

  7. Mike

    Chris Yeh: That’s $336 per child, per week. That is way above the market average for day care. I only pay $110 per week for my daughter. I do agree, though, that the little tikes a expensive.

  8. Derek

    Really can’t thank you enough for this series Ramit ^^.

    Just wanted to point out that towards the end of the post the ‘how I setup my financial accounts’ is a dead link.

  9. NathanB

    Before opening an account, talk to the financial institution in question and ask if they support automatic direct downloads to MS Money or Quicken. ING does not support this which means that instead of just opening Money or Quicken you have to do to the ING website and download your data.

    I’m not a big fan of Microsoft Money, but I am boycotting Quicken and all Intuit products for life. Search google for “Intuit is evil” and you’ll find that Intuit unfarily squeezes both customers and financial institutions for “upgrades”. Details about this are here:

    Thanks for great advice and a great blog Ramit!

  10. Ramit Sethi

    Derek: Thanks, it’s fixed!

  11. Javiso

    Do you consider 401k savings? Also the experts have said to have three to six months worth of savings to pay bills in the event of an emergency. Do you consider this “untouchable savings” savings?

  12. Rayjan

    Great series, Ramit. There’s two suggestions I’d like to share. First, before investing your money you need to pay off any high interest debt such as credit cards. That 20% interest credit card is costing you money you could have used to invest and make money for you. Why throw it away when you can make it work for you? Let’s put it in perspective with a very simple example. Say I have $1,000 in credit card debt at 20% interest and I’ve invested $1,000 in the stock market making about 10%. I may have done well in the stock market but the credit card has given me a net loss of 10%, so overall I lost. Pay those puppies off. Make yourself rich, not the credit card company 😉

    Second suggestion is regarding “untouchable” emergency funds. Three to six months seems about what most advise. Keep in mind that emergency is regarded as serious emergencies like medical, vehicle, busted water pipes in your house, or my computer puked and my thesis is due soon. In other words, not “I forgot my girlfriends birthday” emergency (though she may disagree). You want to consider at least around $5-$10k to cover any possible combination or severity. If your hooptie car busts, you’ll need the down payment. Treat the emergency fund as a buffer that gets replenished. It’s there for quick access in case it takes longer to pull funds from other resources. Also, if you can do so, put it into a yielding account so it gets bigger through compounding interest. 2.5% of $10,000 is $250 of free money. Build this up over time, like one or two years. Unlike the credit card example above, you can make investments while building this emergency reserve.

    Once again, thanks for the great blog, Ramit.

  13. Dave Kaminski

    from that cnn article:

    “Electronics should remain a hot category as prices on must-have items like flatscreen TVs and home theater systems come down.”

    It’s sad that we think of those things as ‘must have’ items. Pfft!

  14. That Dude

    I live in the NYC area and I need a little help in making up my budget. I’m currently employed at a bank, and basically feel like I’m getting paid enough to cover rent and pay fare to head to work. Here are my expenses broken down:

    Rent/Utilities $1,320.00
    Cellphone $59.50
    Sallie Mae $197.97
    Gym $46.00
    Medical $86.42
    401k $552.00
    Savings $50.00
    Food $280.00
    Train fare $60.00
    CitiCard $400.00
    AES (Student Loan) $32.43
    Net: $181.74

    Now my AES student loan is at 7.130% and for some odd reason didn’t get consolidated. I’m expecting a small windfall of cash in the next week which will wipe out this loan, so I’m not too worried about it. My Sallie Mae loan is at 2.875% and I don’t see the point in paying any more than the minimum because the balance is not going anywhere for a long time, and I’ll probably put the extra money to better use in an index fund. The CitiCard is at 0% APR until December. I’m expecting, but not guaranteed, another windfall of cash which I plan to use to pay off the balance before the interest kicks in. Should I pay the minimum on the CitiCard and push more towards savings, or treat the card as high-interest debt and pay as much as I (comfortable) can?

  15. Jonathan Radande

    This is great information that you provide Ramit. I am 23 and I’m happy that I started thinking about the future at such a young age. There are people who wait until they turn 40 then suddenly realize that retirement is around the corner. This only leads them to make hastily decisions with not enough time.

    Are we allowed to have both 401k’s and IRA’s? Do I need to have an employer who opens/manages my 401k in order to start one or can just open one on my own?

  16. Ramit Sethi

    Jonathan R: Yes, you can have a 401(k) and a Roth IRA. We’ll get to that later.

  17. Trevor

    Ramit, you mention making $50K a year… I don’t even make half of that, and I have a mortgage to pay, it seems to me impossible to save more than $50-100 per month, any suggestions in that regard? (in the event your curious where I can seem to live off of such little money, its FL).

  18. Ramit Sethi

    Trevor, that was just an example. First off, $100/month is nothing to be ashamed of. Second, if you want to save more money, there are basically two ways: make more money and/or cut costs.

  19. marcel

    I like the budgeting spreadsheets, thanks.

  20. Steve

    Just an FYI in case you haven’t been to the site. ING Direct will be paying 4.75% on deposits made b/w 1/19/06 and 4/19/06.

  21. gRegor is a nice budgetting application I discovered recently. It’s free.

  22. Leng

    Great advice and very well written articles. I suggest for those who don’t like keeping budgets in Excel, there are a lot of freeware alternatives at Some of them even support Quicken/MS Money formats and will allow you to use downloaded bank statements.

  23. Mike

    Bout time for step three?

  24. m@t

    I did a clever variation of the ‘get the HR dept to split my salary’ system.

    When negotiating my contract, I agreed with management to split my salary into a salary component and a ‘consulting fee’.

    I set up an offshore company in Hong Kong (took about 3 hours and I travel there regularly), and invoice quarterly a fee that is essentially the rest of my salary.

    The benefit of this comes with the taxman. I have lowered my taxable income in my country of residence into a lower bracket, reducing this portion, and then my company (set up in Hong Kong) incurs no tax. Plus – of course – it forces me to save.

  25. Vish


    Great article. Enjoyed reading it. Just wanted to see what you think about how do you decide how much to save when you mostly aware of the fact that a dollar spent when you are young sinlge brings you more joy than when you are old and tied down, spending money on drugs to keep you body running???

  26. Terry

    I earn minimum wage and am paying $44/mo on student loans. The student loans are negatively amortizing. How much should I be investing?

  27. Patrick

    Excellent article. I enjoy showing people the joys of compounding interest. The Vanguard slide show is great. I’ve seen something similar before that had a year by year breakdown of how much money each investor had accumulated, but I cant find it to add here. If anyone knows where to find that or something like it, please post. Thanks Ramit You information is worth a million dollars.

  28. Jamie

    I know this article is 2 years old, but I just found it! Thanks so much – your advice is SO helpful. I know NOTHING about finance (much to my husband’s chagrin) and am TERRIBLE at budgeting and saving, let alone investing. Thanks for starting at the beginning for novices like myself!

  29. Fred

    Hi Ramit, thanks for the article! Note that the “nice picture” you linked to, is no longer available.

  30. Alina

    Hi Ramit, you advice are helpful for USA but not to much for Germany. I get to find some Lifecycle Funds here.