Have you ever looked at your income tax bill year at the end of the year and see that you earned “x” amount of money, but you have no idea where all that money has gone? Have you ever asked, if I earned all that money, why are my savings and investments still around the same level as last year? In this week’s post I would like to visit the very basic step of budgeting. Before anyone can think about investing they should first think about budgeting. Budgeting is simply about building a plan, very similar to a diet plan, where you can review what you are currently doing and see how you can improve your financial health.
Many people overlook this step and think that it is too technical for them or too artificial. This post will aim to give an insight on some easy steps one can take in order to become more financially responsible.
Step 1 – Record Keeping
The first step to budgeting is definitely NOT to set artificial targets on how much you would like to spend on things. That exercise is tedious, irrelevant and discouraging. The best way to start a budgeting plan is simply to start recording your monthly expenses. Thanks to internet banking and the increased use of credit and debit cards we are lucky to have most of the work done for us when it comes to the recording of our financial transactions. All you need to do is to create a simple excel file in which you record you income and expenses for each month. Since every month will have some different expenses and for some even different incomes, it makes sense to have at least a 3 month view of your income and expenses patterns.
A good way of recording your expenses is to categorise them. When it comes to budgeting it is never a one-size-fits-all science. Although certain tips can be applied across the board, each person needs to apply their own personal settings to arrive at the best plan for them. Some examples of categories could be “Utility Bills” in this category you would include items like water and electricity, phone bills, internet bills and the like. Another category could be “Eating Out” in which you would list the amounts paid for meals bought from restaurants and take-out places. So you basically keep creating categories until you cover all your expenses of the past month.
Step 2 – Analyse the Data
After listing all the expenses in their respective categories you should then get sub-totals of all the categories. This will give you a clear picture of where your money is going. Once you have this info it is much easier to see where you could realistically trim a bit of your expenditure. You might be surprised how much you are spending on clothing for example or on eating out. By analysing the data you can start to appreciate where your annual income is going and how you could spend less and save more.
Step 3 – Make a Spending Plan
Now that you have all the info, you should start setting some realistic goals. It is important that you do not try to trim too much, one has to be practical in their approach and also see what is important to them. For example, if Friday night drinks with the friends is very important to you, then do not set any high targets here but simply aim to maintain a reasonable amount of expenditure. In other areas you may find that by making some small lifestyle changes by for example buying in bulk, making less trips with your car or eating in more, you may start spending less. A lot of small changes will eventually add up to a bigger total so do not try to set large targets that are unrealistic in order to have a high goal. But rather start by making baby steps and trimming expenditure gradually in the areas where you would prefer to cut-back.
Step 4 – Review Your Plan on a Monthly Basis
A budget plan is not a static one-time thing but is something that evolves as one’s personal circumstances and priorities change. After you have made your initial plan it is important to see how you did. You should not be surprised to see that you did not meet all your targets and in fact might have spent more than the previous month rather than less in certain categories. The aim is to lower the overall spending so just as long as the total spending is less than that of the previous month you are still pretty much on track.
By reviewing your plan you can get a better understanding of where you are lacking. What you need to work more on. You could also use the review to change your cost-cutting sources – perhaps you might prefer to save money by spending less on online shopping but still go out to eat every weekend. So do not be afraid to change the parameters from month to month. Some months would have more expenditure on many of the categories, such as December. One could for example aim to spend less in October and November to have more leeway in December.
Step 5 – Beyond Spending Less
Once you have been actively tracking your spending habits and have found ways to better manage your financial affairs you should end up with “extra” money each month which was not spent. One may ask, what should I do with these funds which I have managed to shore up through my work and sacrifices? A prudent initial step is to set up an emergency fund. This emergency fund is nothing but money set aside into a savings account that is there to be used in the event that quick cash is needed. From time to time, we all experience unexpected events that would require a cash outflow at short notice. Therefore it is important that before one even considers doing anything else they should first set aside around 5%-10% of their annual income into an easily accessible venue. A fitting product would be a simple savings account with a reputable bank.
Once the safety net is in place then one can start considering other ventures. Again this next step will depend on the priorities of the person. Whether extra money should be used to pay down outstanding debt, to increase one’s savings or to invest the money for future returns is a personal issue. I will be tackling the issue of paying down debt vs investing the money in a separate post in 2016. The focus of this post is to first arrive at the point where one has this option by first learning how to be more financially responsible.
Setting up standing orders or automatic bill payment facilities are a good step towards achieving one’s budgetary goals. These automatic payments are normally used for loans, such as your monthly home loan or car loan payment. However, they can also be used for savings. You may want to open a separate savings account for example into which you deposit automatically €100 each month. Should you afford to deposit a bit more you can make a manual transfer, but at least you know that as a minimum you would be saving €100. This new savings account can act as your emergency fund and eventually as a source of money to invest for the future.
Another good tip is to look at saving as an expense. What is meant here is that you should get into the habit of saving and investing. Just like you would save up money to buy a new car, you should also aim to save up money to place a new investment. Just as you would allocate for example €100 per month for on-line shopping you should allocate €100 per month for saving. So you should put savings into your “must-do” category. So just like you must pay your monthly loan payments, your electricity bill and so on, you also must deposit a minimum amount each month. Once you accept this psychologically it becomes much easier to save more and more.
The Bottom Line
Finding the right budget plan is something that will be different for everyone. We all have different circumstances, different priorities and different obligations. Moreover your plan will undoubtedly change as your personal circumstances change. So do not look at the budget exercise as a one-time plan for the whole of your life. If you need help in this exercise do not be afraid to seek it. Unfortunately when it comes to such personal matters it could be a bit awkward to discuss it with people you know – fortunately there are professional financial advisers that you could consult that could easily help you in this task.