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

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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.

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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.

Related: Can Real Estate Investing Help Me Pay Off $180,000 of Dangerous Debt?

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 in the world that Serge S. and I live in, 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% 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 W2 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 W2 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% 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+ on taxes and life, leaving them $800 to bank.

Imagine if they could save that 30% 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 W2 income from an employer, meaning that it could be gone overnight, I do believe that anything over 50% is risky. Why? Because you need a lot in savings, since you can be fired. Needless to say, few people are there.

Related: 3 Negatively Cashflowing “Assets” That Devastate 20-Somethings’ Finances

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

A 35% 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% 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!

About Author

Ben Leybovich

Ben Leybovich has been investing in multifamily residential real estate since 2006. His area of expertise is creative finance. Ben works extensively with private as well as institutional financing. Ben is a licensed Realtor with YOCUM Realty in Lima, Ohio. He is also the author of Cash Flow Freedom University and creator of a cash flow analysis software CFFU Cash Flow Analyzer.

47 Comments

  1. David Roberts

    I love that quote!!!!! I will always remember that.

    My mentor has alot of quotes, but not that one. He has some personal favorites though:
    1. Don’t be distracted by shiny ibjects in the corner.
    2. Equity is where money goes to die.
    3. Does it make sense? No, it makes dollars.

    How can you fail if your next deal is better than the last?

  2. KEVIN SAPP

    Hi Ben,
    I like and appreciate the lighter writing style now. I’m glad that you have chosen to be less controversial on this article. This is good, once you acquire your Tesla, I’ll be forced to treat you more like family and also forced to like you (grin). P20242, blue. Hopefully, the Tesla addition is not impacting your burn rate and if a business lease, I’m certain that you have investigated the reduced warranty which comes with this.

    Back to burn rate, if your buddy Max is in practice for himself, seems he would have (almost) as much control over his tax rate as you, that is, he would not be a strict W2. Just sayin’

    You will need to sit down for this Ben, are ya, I’ll wait. I completely agree with ya on the burn rate. Financial independence is (IMHO) more a factor of what you spend than income. My burn rate is very low in dollars and percentage of income. Being financially independent, gives me the option to work or not, I currently choose to, but not for much longer. My JOB income is heavily taxed and there is nothing I can do about it. Accountants say things like “you are who they are targeting” and “most people dream of making what you paid in federal tax” like that is supposed to make me feel better.

    Folks, get your tax house in order, show as little income as you can. Once I leave the JOB, I hope to have so little taxable income that I’ll be eligible for free Obama!Care and my kid will qualify for need based scholarships. (Took a lesson from Ben on that controversial statement!)

    The only way to win the game is to keep as much as you can. Then you can choose where you wish to be philanthropic.

    • Ben Leybovich

      Some people know how to read between the lines – you are one of them, Kevin! (were you sitting for that)

      I have to address several points:

      Interesting to know that I come off less controversial. This tells me I need to throw some wood in the fire 🙂

      Very nice on the Tesla family stuff. I’ve never met a Tesla owner who wasn’t happy with the car. It’s the future today. It’s incredible what Musk has done – excellence without compromise personified. It’s the stuff romance in life is made of. It’s how we do it…How has your experience been?

      Tesla is a personal purchase. I’ll deduct the miles in lieu of depreciation. Works just as well, but financing/insurance/warranty are all better. We should start a BP Teslarati. Serge S. is in the club as well – he introduced me, as the matter of fact 🙂

      I think it’s important to realize that one can’t save his way to prosperity. When everything’s been cut, there’s nothing more left to cut. At some point, the top line has to be pushed. Diversified revenues are a requirement, because it’s safer and more tax-advantageous. Like you say – W2 tax situation is bad, and will get worse.

      If the only way to win the game is to keep as much as you can, W2 is out. Schedules C and E are in.

      Thanks so much, Kevin. I’ll try to piss you off a little more next time 🙂

  3. Joe Harper

    Another home run post, on the topic of personal finance – not how to make money in real estate. I should be so lucky to have a friend ask me advice, much less a vendor or an attorney.

    Personal finance is the cornerstone of early retirement and I’m glad somebody is spreading the news.

    My burn rate on my W2 is about 90% but on my rentals is about 65%. My goal is to get that 65% rate to cover all my “living” as you put it. It wasn’t until I started tracking every penny that my life turned around …. but it still took four more years to buy my first rental. They don’t teach PF in school.

    I’m curious: are you financing the Tesla?

    • Ben Leybovich

      Hah – they teach very well in school how to be an employee, and if you done’t mind – you’re all set 🙂

      As to Tesla – of course it’s financed. I am not in the habit of writing checks of this magnitude for depreciating assets. I am not paying for it with W2 income, though – most notably because I don’t have any…:)

      I just don’t get tired of telling people, diversified income is necessary for stability. With W2 income you are one illness away from disaster; you are one pissed off co-worker away from se-la-vie

      Diversify your revenue. Find ways to control your exposure to tax, and you are set…

      • Chad Carson

        “I am not in the habit of writing checks of this magnitude for depreciating assets.”

        If you wouldn’t write a big check for a depreciating asset, why would you finance it? I don’t get that one. You’re basically just agreeing to write an even bigger check, just over time.

        The only thing I can justify financing is a quality income property with steady income.

        • Ben Leybovich

          Chad – there’s a couple of points here:
          1. If I had to write the check out of W2 or 1099 income, I wouldn’t. There was a time when I did exactly what you suggest – buy passive income! Why – to get away from W2 and 1099 income.

          Today, while I don’t make as much as some, everything I do earn is passive and diversified. As such, simply put, I’ve determined that my income is diversified enough that at 40 years of age the additional debt service stemming from a purchase such as this is immaterial.

          2. The ROI I can generate on cash vastly exceeds the cost of the debt service. So – it doesn’t make sense to deploy cash in this way. I’d much rather invest it in some way.

          In the beginning, when we have nothing aside for the necessary evil that is our JOB, every free penny needs to be invested – agreed. Thankfully, I am past that and can afford to place a bit of value elsewhere…

          3. Lastly, borrowing money to buy a car can in no way be presented as a smart financial decision – it is not. But, it is important to me for personal reasons, and I frankly can afford the debt service. So – I keep the cash and invest it my business, producing exponential returns, and I borrow at 4% to buy a depreciating asset.

          Life only happens once, and it’s not about money…

          Thanks so much for jumping in, Chad!

  4. Matt Santos

    Hi Ben! I enjoy reading your posts and hearing you on the podcast from time to time. Awesome concept that seems so simple, I’m surprised I haven’t heard it before!

    Keep up the good work, I appreciate your incite and perspective.

    • Ben Leybovich

      Thanks indeed, Seth! I hope the other message doesn’t get lost, that while expenses have to be compressed, mostly through tax planning which is impossible with W2 income, the top line must be pushed and diversified, which is also impossible with W2 income…

      Where does that leave us…?

  5. Christopher Kaflik

    Wow I never thought of it as a “Burn rate” but more of a savings vs income.

    How would you calculate the tax portions of this even if you’re working off a W-2?
    I’m probably going to get 90-95% of the taxed income back next year.

    Burn rate on W-2 is 60% (incl. Taxes)

    • Ben Leybovich

      Christopher – income tax, State/Federal, is assessed on all taxable income via a graduating table, right? So, if you make $75,000 this year, you know that your blended income tax rate is likely about 13%+. In addition, you have FICA – let’s say 7.5% more. Let’s call it 20% effective exposure and call that even.

      20% of $75,000 is $15,000 – this is your burn due to tax exposure. So, when you say your burn on W2 income is 60%, and that includes the 20% tax exposure, what you are really saying is that your life is costing you 40% of your gross. If this is the case, then you are doing pretty well, considering your income is W2.

      When you say that you are going to get back 90% of taxed income back, I am assuming a refund. If so, good for you! The only (sort of) problem is that you have to pay for bread today – can’t really wait for the refund 🙂

      Thanks for chiming in!

  6. Nik Shamaro

    As well as the burn rate in relation to your annual income, a good indicator to consider is the burn rate in relation to your net worth (annual income + asset value – liabilities). The aim is to get into the single digits ideally.

    It’s a great financial health check indicator that lets you know how much return you should be aiming for when you are employing capital in order to grow your net worth.

    • Ben Leybovich

      interesting, Nick. Yes, I agree – Net Worth is important to keep track of, especially in RE. Why – because the only type of cash flow that is stable enough is coupled to quality assets. So, yes – wealth equation certainly must have an equity component.

      Having said this, equity is a function of the marketplace, which we do not control in the same way as our cash flows, and burns. For this reason, I think that pulling CF and equity together mght be quite misleading… Thoughts?

      • Nik Shamaro

        With regard to equity, you can look at the long term market trends also. So, for example if a particular area has a 3% growth average, then you can also include that in your equation based on the amount of equity you have. Similarly, you can subtract inflation (again based on long term trends).

        You can also argue that you rental income is a function of the marketplace, where voids or increases in demand due to job creation for example can decrease or increase your ‘net wealth’ figure.

        The way I consider this equation is as a snap shot in time. So, at this moment, if nothing major happens in the market, I am spending x% of my wealth per year, so to keep growing it I need to earn Y% on my investments.

  7. Michael R.

    Great article, Ben! I definitely enjoy reading articles that stress the foundation principles that allow us to buy so much as one great deal, let alone one after another. You can have someone smack you in the face with a great deal but if you can’t save some the necessary coin to take action what good is it…

    I’ve spent the past 8 months coordinating my finances to allow for a 35% burn rate after reading this article by Mr. Money Mustache: http://www.mrmoneymustache.com/2012/01/13/the-shockingly-simple-math-behind-early-retirement/. So far it’s at 40% and it honestly doesn’t feel like I’m missing out on anything (just doing away with the superfluous). He adds in the assumption of 5% investment returns and living on a 4% disbursement rate. Add real estate investing to the equation and it would be pretty much embarrassing not to be retired in the next 15 years.

  8. james russell

    i so badly want to have the decisions i have been making in wholesaling (newbie), by next year to start to make it so i no longer have a 98% burn rate. i support a family of 4 on my w2 salary, which is nothing huge, and am sick of feeling like we have to choose between food or gas, or diapers for that matter. i appreciate posts like this more than most because it gives me massive inspiration that i AM on the right track in my decisions. thank you sir.

  9. Travis Sperr

    What a fantastic read, Ben. Like you, my wife and I live far below our means but comfortable, leaving us more than 60% of our income to invest and grow wealth. Discipline with personal finances is what keeps so many people from getting into real estate investing or growing wealth in general – when someone tells me they don’t have the money to get started I like to ask how much their car payments total – asking burn rate is a little less candid with the same result. What a great reminder for new or seasoned investors to take a look at the bottom line at home rather than in our business to understand what is helping or hindering success.

    Thank you for posting.

  10. Tim Hoffman

    Great article Ben! I had never thought about my cash in that way before. Since this is a new way of looking at things for me, I have a few questions. First, I am a full time investor / landlord with NO W-2 for the past 15 years. Between business and household we save about $4k/mo. Is the gross, really the gross rents or the net rents (rent minus mtg pmt)? Is it business Net Income (after business expenses)? Is there a small worksheet you can share?

    Regarding quotes to live by; my mentor gave this one to me 17 years ago and I pass it on when I can, “If you are willing to do what others are Not for 10 years, you can do for the rest of your life what others Can’t”

    • Ben Leybovich

      Tim – no. Gross household income in the context of this article is really Net to you from RE and businesses. There is only one caveat – since most businesses are set up as either LLC, Partnerships, or S Corp, the tax is flow through in most cases. the S Corp structure allows for pay roll, which helps with FICA, but to keep things simple in this article I presume all federal and State income taxes, as well as FICA as part of your burn rate.

      So – Income comes in. Your burn items are:
      Less all business expenses
      Less all taxes- business/personal
      Less cost of living expenses for your family

      All of those numbers added up are the burn. If you juxtapose this burn to the Gross Receivable (total income into the household), you will arrive at the % burn rate.

      What’s left is your wealth accumulation relative to the income component.
      Hope this helps>

  11. Tim Hoffman

    Great article Ben! I had never thought about my cash in that way before. Since this is a new way of looking at things for me, I have a few questions. First, I am a full time investor / landlord with NO W-2 for the past 15 years. Between business and household we save about $4k/mo. Is the gross, really the gross rents or the net rents (rent minus mtg pmt)? Is it business Net Income (after business expenses)? Is there a small worksheet you can share?

    Regarding quotes to live by; my mentor gave this one to me 17 years ago and I pass it on when I can, “If you are willing to do what others Won’t for 10 years, you can do for the rest of your life what others Can’t”

  12. Daniel Kenney

    Excellent article Ben! It amazes me how many people live on the mouse wheel, paycheck-to-paycheck with little to no savings, despite good or even great income from W2 jobs. In fact, it stresses me out just thinking about it…

    Just reiterates that building wealth is very much a mindset and requires a pronounced change in perspective. It’s not necessarily about living as frugally as possible but evaluating your personal income/CF statement with the same scrutiny as you would a business (or property :)).

  13. Jeff S.

    Oh, I see it is gross rents x 50% (or whatever) – (PI +income tax + living expenses) equals 65% of gross to reinvest.

    Or 50% of rents + PI + income tax + living expenses equals 35% of gross rents as your goal assuming 50% expense on rents.

    • Ben Leybovich

      You are telling me you can’t generate 65% more income than your cost of living? Perhaps not with one strategy and/or asset class, but most definitely possible 🙂

      In fact, you are right – simply on rentals this is impossible to do. Most people who succeed at this, utilize rentals for a portion of their cash flow, and as a depreciation play to offset expenses on other income. But, it most definitely take diversified income among asset classes and techniques 🙂

      Bottom line, as long as it’s not W2, I don’t care how I do it, as long as the money comes in…

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