Are all financial advisers not paying taxes?
One of my pet peeves in reading about personal finances, both online and in books, is that so many people leave out the consideration of taxes. This is also the case when people talk about money in the real world, but since this conversation comes up very rarely out in public it isn’t as prevalent. Often, an article will state, you shouldn’t spend any more than 30% of your income on rent. This is a fine rule of thumb if you are spending only 30% of your net (how much money hits your account) income. But it gets into scary territory when considered on gross income (how much money you are “making”).
Rent spending example
To illustrate, let’s look at a person making $50,000 a year.
| Income | $50,000 | |
| Monthly Income | = 50,000/12 | $4,166.67 |
| Maximum Rent | =$4,166.67 * 30% | $1,250.00 |
According to the recommended financial advice, this person should be able to spend up to $1,250 for rent on an apartment. This is not including the utility bills, furnishings, or maintenance supplies such as cleaning stuff and toilet paper either. From my experience, this would be a ton of money for someone making a cool 50 g’s on rent. Following this type of advice will leave you struggling to save any money, and wondering why you’re always coming up short each month.
Pay yourself first.
Further, looking at financial advice this way violates one of the core tenants of good financial advice. That is, to pay yourself first. Or as George S. Clason put it in The Richest Man in Babylon (an amazing, and highly recommended simple book on personal finance), “Put thy Purse to Fattening.” In general, you want to put some amount, let’s say 10%, away before looking at expenses.
These will be deducted from your paycheck prior to hitting the bank if things are set up well. 401k contributions, HSA contributions, and automatic IRA contributions will all take away from your net income and are great cornerstones of a solid financial plan. These also have the benefit of reducing the amount of taxes that you’re required to pay.
Lastly, taxes will generally take around a 3rd of your income. This will be more or less depending on where you live. Putting all of this together, we should expect to only see about 60% of our income. This is the number that I use as a shorthand when trying to do quick calculations to figure out how much I can afford. A better spending pattern would be the following:
| Income | $50,000 | |
| Tax Advantaged Savings | =10% | $5,000.00 |
| Taxes | =($50,000 – $5,000) * .33 | $14,850.00 |
| Net Income | =$50,000 – $5,000 – $14,850 | $30,150.00 |
| Max Monthly Housing | =30,150 * 30% /12 months | $753.75 |
Notice it says max monthly housing and not max monthly rent. After subtracting $50 – $150 for utilities and general miscellaneous expenses, you would be left with $600 – $700 for rent. This is much more reasonable spending for someone making 50k per year. Remember, base things off of your after-tax income, and always save some money for yourself before anything else.
