Benjamin Franklin, one of the Founding Fathers of what we know call the United States of America once said, “if you fail to plan, you are planning to fail”. hat is why budgets are such a big part of personal finance. An individual’s budget is the starting point of achieving their financial goals. It is so important because it forces you to come to terms with how you spend your money and that for many, is no easy task.
People often get overwhelmed when they think of creating budgets and choose to ignore it. Their fear takes control of the situation. Not the fear of the unknown because people don’t know what they are spending money, no. It’s the fear that, you have to put down on a piece of paper, what you already know is the problem. These activities could be betting on sports, excessive alcohol purchases, and shopping sprees.
The principle of personal finance is quite simple, it is to plan for your financial goals. You can only work on this plan once you understand your own situation. Budget = a plan on how you will spend and save your income.
The first step is to identify your income and how much you expect to earn from those sources on a monthly basis. If your pay is not constant, it’s okay to estimate, be as realistic as possible.
The next step is identifying how much you intend to save. I have mentioned it before, it is paramount that you pay yourself first from any income earned. You, in this context, related to your future self. Your future self will thank you for having this extra cash when the time comes. I divide my savings by: topping up my emergency fund, contributing in a tax-advantaged retirement account, and buying stocks.
You will be saving for different reasons, such as retirement, a down payment for your home or starting a family, and this will guide your savings. Make sure you are putting money into an emergency fund every month until you are comfortable. An emergency fund should cover 3-6 months of your living expenses. It is an amount that should cover your expenses if you were to lose your job tomorrow.
No amount is too small when it comes to saving, make sure you keep saving consistently and without fail. Saving money will not make you rich. I will say it again, SAVING MONEY WILL NOT MAKE YOU RICH. But, there may come a time in the future when you will come across an opportunity you wish you had some cash to pursue. That little pile you are sitting on can be the difference between going for it and staying in your comfort zone. But it extends to more than that, it could be the difference between making 10% on your investment or 40%. The difference is HUGE. With 40% you would be doubling your investment in a little more than 2 years and with 10% it will take you almost 7 years. This is a simple analogy but one that forms the basis of the rule of 72. The rule of 72 is a method to determine the time taken to double an amount.
After identifying the amount you want to save, the scary part of budgeting begins to show itself. Identifying what you are currently spending your income. A neat way to look at is to start with 2 categories: wants and needs. Start with your needs, this is what forms part of expenses you have to incur to live on this planet. Items like rent, utilities, food, and healthcare may form part of this. These are the essential items to your survival and you need them come rain or shine. In my budget I have some of the following items classified as needs
- Airtime – I need to communicate with friends and family
- Healthcare – This includes medication and insurance payments divided into 12 months. Since, I don’t have an employer sponsored plan I need to factor this into my monthly expenses
- Utilities – House maintenance, water bill, electricity token purchases and internet charges
- Education – Improving your life and learning is a human need. If you’re not learning every day, you need to check yourself.
These expenses are usually constant and you have a very good idea of how much you spend on them. This is part of your budget is the foundation of the long term goals you have about your life. It will serve as a compass for your future financial decisions- whether you want to believe it, now or later.
The second part is where a lot of people have trouble: realizing what it is that you want and what you need. This is part of the budget may change from month to month and you may think, “Why even bother?” It can be hard to estimate these, that is why most personal finance ‘gurus’ suggest recording all your transactions for a month. I have done this in the past and it has helped but it can get a little tiresome keeping track of everything. It is my nature to record everything so it works for me but it might not work for you. Do what you are comfortable with. That’s why they call it personal finance.
You can write out categories of your estimated expenses for the coming month and tally them up. Some categories for wants include but are not limited to:
- Personal care i.e. haircuts & salon visits
- Clothing purchases – you will survive without buying a new pair of jeans every month
- Eating out & going out for events
- Entertainment i.e. Netflix and other subscriptions
- Other purchases that are not planned for – You should always put aside an amount for unexpected buys
Once you have tallied your savings, wants and needs, you will have a clear picture of what you spend your money on. Put your income and your savings and expenses side by side and start comparing. Are you spending more than your income? Are you saving enough? Are you in debt and don’t think you can get out of it? The idea of a budget is to set you up for success but it also allows you to check your spending. Budgeting is more of an exercise in introspection than many people give it credit for. You should be spending on things that make you happy and that will help you grow.
The 2 obvious budget lessons you will learn – spoilers ahead:
- If you are spending more than your income, you need to cut your spending on some categories
- You need a lot less to live on than you think (if you only count your needs).
I hope this post can be a launching pad for you to create a budget if you don’t already have one, or examine your own budget. Till next time!