Burn Rate: What Percentage of Monthly Income Is It Safe to Spend?

So, I had lunch with a friend of mine. He is an attorney. He’s a young guy who’s been in practice for about four years now. Let’s call him Max.

I was introduced to Max a few years ago by a mutual friend. I started using Max for a few things, such as all of my evictions (I think he’s done four for me in as many years) and some entity setup work.

I had lunch with Max today. I am setting up another entity, and he met me at a favorite bistro downtown to discuss the specifics.

About Max

Max is a really nice guy. He is a few years younger than me. Max is married to the girl of his dreams, and they have a young child.

Until recently (thanks to me), Max had subscribed to the notion that if you study hard, get good grades, and become a lawyer, the financial thing will take care of itself. Naturally, this line of thinking resulted in Max accumulating significant amounts of student debt.

That right there pretty much describes Max. Does it describe you?

At Lunch

Business talk took no more than 15 minutes. I put my scribbles on a few pieces of paper, and afterwards we simply sat there and caught one another up on the going-ons in each other’s lives. Max talked about why he recently switched law firms in hopes of growing his practice faster. And I told Max about growing my businesses and about the Tesla Model S that I just ordered. He immediately brought it up on his smartphone and started asking questions.

I could see that Max, sitting right there in front of me, was changing before my eyes. All of a sudden, we were no longer equals—I could sense it in the air. All of a sudden, Max started asking questions that a student who is trying to find a path toward financial success asks.

Four years ago we were in the same place. Now, as far as Max was concerned, I’ve leapt ahead.

The Lesson I’ve Told You Guys

A few years back, I told Max about the lesson my mentor taught me. I told you guys about this lesson, as well. It goes like this:

To achieve success, make sure that the deal you do today is bigger and better than the one you did yesterday. This, in and of itself, defines progress in the direction of success!

I took this lesson to heart in a big way. I’ve made sure to adhere to this principle. Max, on the other hand, has spent four years doing the same thing each and every day—just like a hamster on a drum.

That right there describes Max. Does it describe you? Are you doing the same deal over and over?

It Was Time for Me to Ask a Question

I asked the following: “Max, what is your burn rate?”

Max didn’t know at first what I meant, so I explained that burn rate is the amount of gross income that is being spent on taxes plus living expenses. How much of what you earn do you burn?

For example, if your gross income (this is before taxes) is $8,000/month and you are left each month with $2,000 of savings, then your burn is $6,000. It really doesn’t matter how that burn is allocated. All that matters is that your burn rate is 75 percent of your gross.

Though, I will tell you that out of the $6,000 that you are spending, if your gross comes to you via W-2 income, you are more than likely spending effectively at least $2,000/month on taxes. Imagine if that could find its way into your pocket.

It’s not possible with W-2 income! But that there describes Max. How about you?

And Here We Are

What Max told me when he figured out what I was asking him flat out shocked me. Not because it is out of ordinary, but because I expected him to be doing better. Max told me that they bring in $800/month more than they spend.

I don’t know what Max’s gross is and therefore can’t tell you definitively what percentage $800/month of savings represents. But I do know that they live very frugally and simply, and thus I imagine that Max’s burn is likely 90 percent of his gross pay. I am thinking that between the two of them, they likely generate $8,000/month top line, of which they spend $7,000-plus on taxes and life, leaving them $800 to bank.

Imagine if they could save that 30 percent they are giving Uncle Sam. Just sayin’.

That right there describes Max. Does it describe you?

You know the scary part? If this describes you, you are doing better than most. After all, you are in fact spending less than you take in, and that’s something. 🙂

How Much Should Your Burn Rate Be?

That’s a loaded question. If you rely on W-2 income from an employer, meaning that it could be gone overnight, I do believe that anything over 50 percent is risky. Why? Because you need a lot in savings, since you can be fired. Needless to say, few people are there.

If you are living on passive income, however, 50 percent is likely OK. Why? Because passive income is much more stable than earned. However, something in the 30 to 35 percent range is great! And this includes the tax exposure.

A 35 percent burn rate is my goal, though I am not quite there yet. A lot of my friends are there (and even better), which helps me understand the dynamic of what it takes.

Achieving a burn rate as low as 35 percent involves both growing the top line via diversified revenues and compressing the bottom line. However, the line item you must worry most about on the bottom line is tax exposure, so take tax planning very seriously!

Wrapping Up

As we got up to leave, Max asked when we could meet again; he wanted to ask questions about real estate. I can’t help but feel that I moved a tectonic plate within his universe. I hope that I did. But he has a ways to go. All he can figure right now is that he needs more clients in his practice, so he can earn more money.

What do you set as your “burn rate” goal?

Leave a comment, and let’s discuss!

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.