Personal Budgeting
Personal budgeting is the tracking of your expenses to make sure they won't exceed a set limit (budget). This is usually monitored over a specific time frame. Businesses mostly use 12 months whereas private households often watch their cash flow on a monthly basis. In my financial planning work I noticed that many people don't like budgets and most of them don't have one. It seems that budgeting is one of the daunting tasks we never have time for. Budgeting is reduced to checking if there is still money left in the bank account at the end of the month. If there is, we read the balance and set this as the new maximum spending limit. This is the same like saying: "Let's go and spend it all". It defeats the purpose of budgeting and there is no way how we can be in control of our money. When budgeting we often run the risk of diving into details right away resulting in a budgeting process that is complex and boring. On this page, we will introduce a simple personal budgeting system that works. Once in place, you can then detail your budget categories as you see fit without huge complexity. Spiralling out of controlDuring my studies, I realized that the income from my casual jobs only covered my basic needs. I had a few little luxuries and extras that I could afford. However, this was mainly because I was living at home at much lower costs than elsewhere. It took me years to save up for my first motorbike but I did. Needless to say that only with personal budgeting I was able to save up enough for that specific goal. Then, I used about 80% of my money for 'basic needs' and allocated 20% for nice-to-have extras which I called 'luxury needs'. I'd just call it an 80%-20% profile. I graduated and landed my first big job. Guess what happened then? - I was so excited about my big salary that I started a spending spree. Suddenly, I had money available for 20% basic and 80% luxury needs. - Great! In no time my basic needs turned into a higher living standard which spiralled to 80% of my net income and I had only 20% left for luxury treats on top of that. My higher living standard, although nice and all, meant that I had to spend more money to keep my lifestyle. Yes, I did get that car, that flat, those gadgets and upgraded my wardrobe and shoes. Everything felt good at first, and believe me, I did not use any personal budgeting then. Somehow my subconscious intervened: How will I ever be able to make more money if I keep spending like this? Everyone falls into that trap sooner or later. We burn our incomes by increasing our living standard to a degree that it is emptying our pockets. A higher living standard is not luxury; it becomes a basic need just too easily. We get used to it and it becomes part of our new lifestyle, a necessity. It is like the rich lady who needs her car with chauffeur to go shopping. She'd never catch public transport to do the same. It's a basic need to her. Which profile are you? How much are you spending? - Are you the 80%-20% type, or, maybe 60%-40%? Avoiding the biggest money trapI was determined not to fall into that same money trap again. I needed a way out of that spending spiral so that I was in control of my cash flow. - I made a plan. Unknowingly, I created my first personal financial plan to address my splurging caused by my great but limited income. My plan included a personal budget for things that I really needed and a few nice-to-have things but in moderation. Personal budgeting is about being in control of your money. - If you don't have a personal budget you're not in control. I said basics must come down to 70% of my overall costs and luxury down to 10%. This left me with a spare 20%. This is high level personal budgeting that works; unlike the regular bank balance checks. That way I was able to get control over my money back and avoid the spending spiral. The result was that I squeezed 20% of costs gone elsewhere out of my 80%-20% profile which I then allocated to wealth creation. From then on, there was more money coming in than was going out. This is also known as positive cash flow. Accordingly, my financial profile changed to a 70%-10%-20% profile. I had split my total net income to:
After all, it wasn't too difficult to be a bit more modest and, thankfully, I hadn't got fully used to my new lifestyle yet. Taking personal budgeting to the next levelWe use money in different ways every day. In personal budgeting we categorise these into the following transactions:
Spending could just as well be the top category of all money transactions. Here it is the purchasing of goods and services so we can live, i.e. for basic needs. We all need food on the table, shelter etc. and our cars need refuelling. Borrowing can in fact be used for basic, luxury or for wealth creation needs. If we borrow money to buy a car it might be a necessity (basic). However, if it's an expensive car it's rather a luxury. If we borrow money to invest it becomes part of wealth creation. Saving is undoubtedly a prerequisite to any wealth creation plan. We save money by setting it aside for later, or, simply by not spending it. Investing is the process of creating wealth by using saved money to buy assets that will give us additional returns. Insuring has many faces too. If I insure my house that is a basic expense item; doing the same for an investment property is part of wealth creation and using insurance for my yacht might rather be a luxury expense. Personal budgeting frameworkA personal budget is tailored to your financial circumstances. Personal budgeting looks at all your income sources and expense items with the goal to make sure that the total of your expense items is less than your net income. Here is a simple process you can follow for creating your own personalised budget:
It takes a fair bit of time to go through all these steps. I usually start out with an Excel spreadsheet so that I can save and add things later if necessary. That allows me to build my budget over a couple of sessions. There is also a variety of personal finance software available in the market. They will give you the functionality to enter budgets and track your expenses. However, if you're doing a budget for the first time, I suggest, you stick to simplicity and a manual approach. Software programs are designed to provide sophisticated functionality for many different situations. You may find this a bit overwhelming at the start. We have put together a personal budgeting framework for you that will save you heaps of time because it's based on our top down approach as illustrated earlier. You'd still have to do your research and collect all the bills but you can start categorising right away when using the following framework:
Looks familiar? Of course! - We've combined the simple concept having a financial profile with the possible money transactions. This will help you going through steps 1 to 4 much faster and you won't have to re-categorise things in step 5 and 6 because it's already done. Personal budgeting can be extended to a more advanced level where we can also allocate budgets to assets and liabilities. This is beyond this guide but often available in professional accounting or financial planning software that we use. For example, financial planners can include expected growth of assets and related investment returns (budget amounts) to run comparisons against actuals and see how well investments are performing. You might find these additional pages about budgeting tips and money saving tips useful. I'm sure you can make good use of them too when putting together your personal budget. Clear your emotionsEvery now and then my two teenage sons show me the latest mobile phones or a piece of electronic music equipment that they want to buy. They must have it and the offer is only available now. It is a 30% off deal that will save them quite a bit of money. I usually ask them a question: "Do you know how you could be saving more?" Of course by now, they know my answer which bluntly is: "If you don't buy it at all." I'm not saying they shouldn't buy their gadgets at all. I'm just making them think twice. Each time they want to buy something they have a choice. The real question is not if it's a bargain or not. The real question is:
In the meantime, my rhetorical question has become my sons' subconscious awareness. It's given them a way of keeping their emotions and excitement about a new purchases at bay so that they can make a rational rather than an emotional decision. Don't get me wrong! - We all want to have a life but we don't need the latest upgrade of every iPod every time. Instead, we want to exploit all avenues to accelerate wealth creation. More information:
Importance of Financial Planning
Return from Personal Budgeting to Personal Financial Planning www.Discover-Financial-Freedom.com
|
