Budgeting 101 – Why do I need a budget?

This is the first in a series of educational articles on budgeting. The series is part of a package put together to assist people to control their spending and make informed choices about their money.

This first article deals with some basic ideas around budgeting and why it is so important for people to get on top of this. It is followed by a second article that goes into some more detail about budgeting fundamentals and the basic principles that underpin the workings of a good budget. Articles three and four deal with the mechanics of constructing and implementing a budget in some detail. They complement the other budgeting tools provided as part of this package and will help you to understand the logic behind the spreadsheet that has been provided to you. The fifth article is meant to be read in conjunction with articles three and four. It provides some suggestions as to how to structure your personal finances outside of your budget, which will complement the techniques discussed. These structures are quite simple and will be useful in helping you track and control your spending on an ongoing basis. The article can be read at any time and you may find it useful to refer back to this article several times as you move through the rest of the series.

Why Budget

There are countless reasons for maintaining a personal budget. A quick Google search will bring up a wealth of information on this topic. In essence however, they can be summarised into two key points.

To Control your Expenses

Getting your personal spending under control is the single biggest thing you can do to improve your financial situation. For most people however, money is an extremely emotive subject and it is emotion that is often the biggest obstacle to getting your personal finances under control. With this in mind, much of what follows deals with the psychology of money and the various ways that we undermine ourselves when it comes to our finances.

Overspending in its various forms is the one thing above all others that will stop you from achieving your goals financially. One of the biggest mistakes people make in life is to come to this realisation too late. For most people as children, money is not an issue in which they have any involvement. Most children have a limited concept of money. It extends to the fact that their parents have it, and they don’t! They don’t think to ask, how much money do my parents have, do they have enough money, are they happy with their financial situation? You just know that they have this thing and you do not. If you want something your parents buy it for you. If they can’t afford to buy it for you, in most cases they just say “No you can’t have that.” Rarely will they say “no I can’t afford to buy you that.” So even if your parents are experiencing financial difficulties, you are blissfully unaware it. You may be aware of the fact that your friends parents may have more or less money than yours do, but at its heart your understanding of money is as simple as “Adults have money, Children do not!” which leads to the flow on assumption that “Adults have money, so when I grow up, I’ll have money too!” It will just sort itself out. It’s something I can worry about later. That’s an appropriate attitude for a child. The problem is it’s also an attitude we take into adulthood. That’s often our first mistake.

When we do grow up and we get our first job, we do then have money of own. But often it doesn’t seem enough! That’s ok we tell ourselves, this is just my first job. Everyone starts out small. As I get older I’ll get more experience or get promoted and earn more money. So I’m not going to worry about money now. It’s something I can deal with that later. It will sort itself out.

Then you do get that promotion, or that better paying job and still you don’t seem to have enough, so you put off saving and keep spending. But that’s ok, you’re still young, you’ve got plenty of time. It’s something I can deal with that later. It will sort itself out.

The problem for most people is that they keep putting it off. Some common excuses might be:

• I’m about to get married and once we have two incomes we’ll be ok. We can worry about it then.

• We’re young and we’ve just got married, we want to enjoy life before we have kids. Once we have a family, we can worry about it then.

• We’ve just had kids. Kids are expensive and we’ve just gone back to one income. It’s hard enough to make ends meet as it is. Once the kids are bigger and my spouse goes back to work we’ll have more money, we can worry about it then.

• We’ve just been hit by a few big bills lately and once we get past those we’ll be in a position to do something. We’ll worry about it then.

• And on and on and on.

The problem is that it won’t sort it out later. The only person who can sort it out is you. If you are unhappy with your financial situation, then you need to make a change. If you don’t make a change, then your situation will remain the same. If you manage your money poorly in your twenties and never change your behaviour, then you’ll still manage money poorly when you’re in your forties, fifties and beyond. It won’t just sort itself out! Even if you do get a better paying job, or get an inheritance, or even win lotto; if you don’t get your spending under control, then you’ll just spend it all and find yourself back where you started from. The first step towards doing this is to have a budget.

Another common mistake for younger people is to continue trying to live the lifestyle your parents lead. If you have grown up in a family where your parents were reasonably successful financially, you will be used to having certain things, be it a nice house, or nice cars, or overseas holidays. By the time you leave home however, your parents are probably in their forties or fifties, are in their prime earning years, and most likely earn two or three times your graduate or apprentice wage. So while going to Bali each year on holidays may be affordable for mum and dad, it’s not necessarily affordable for you. People can get into a lot of trouble with credit cards and personal loans when they try to live beyond their means in this fashion. Even if you don’t fall into those traps, it can often affect you spending behaviour much later in life where you feel you have a good job and are earning a good wage but you still spend everything you earn. This may well be because you are trying to live your parents lifestyle, not your own. It probably took your parents twenty or thirty years to get to a point where they could afford the things they have. If you don’t realise what is going on in this regard, you could spend twenty or thirty years living beyond you means and getting nowhere financially. Once again the first step in addressing this situation is budgeting.

Everything we have discussed so far relates to psychology and your feelings and emotions towards money. It is important that you understand this, and recognise the ways in which your own thoughts and experiences dictate your approach to money. It might be that you bury your head in the sand and refuse to deal with the issue because you find it stressful. Alternatively you might refuse to acknowledge there is a problem in the first place because you don’t like to admit you have been doing something wrong. However it manifests itself, the first step in getting this on track is to acknowledge that you need to address your spending and make a commitment to doing so. We do this by committing to a budget.

Empowerment

I stand by all of what I have said above. It is a very important concept to get your head around. I think an even bigger reason to have a budget however is because of the control it can give you. Many people view budgets as a chore and think of it like a diet. They think that by budgeting you are depriving yourself of something. I view it in the opposite way however. Having a budget is empowering as it allows you to make informed choices about what you do with your money. Having a budget doesn’t deprive you of anything; it simply provides you with information. If you choose to buy a car you can’t afford, having a budget won’t make this decision any more or less affordable. It will simply inform you of the implications of what you are doing. Even if you don’t like what it tells you, at least you go into the decision with your eyes wide open.

Equally as important in this area is that if you are able to effectively budget, it will take a lot of the stress out of managing your money. Money is a significant cause of stress in people’s lives. Fighting over money contributes to one in three divorces . Everyone has had that sinking feeling when they get a large bill for a credit card or car maintenance and realise that they don’t have the money to pay for it. Another common complaint is when large expenses fall around Christmas or birthdays. When I was younger my car rego and insurance was due in December and Christmas was always a struggle as I would never have enough to pay for the car as well as buy presents for the family. Once you start budgeting however, most of this stress goes away. It really is liberating to get a bill in the mail and know without even having to think about it that I can afford to pay it. That’s not because I earn a lot, but simply because nine times out of ten it’s budgeted for. That not to say that it’s a prefect process, or that you’ll never get hit with unexpected bills. One of the points I will raise in a subsequent article is that you need to expect that you’ll get this wrong sometimes and that on occasion you’ll blow out your budget and that’s ok. What I am saying is that by budgeting effectively you only have to stress about money 10% of the time, instead of 100% of the time. That’s a pretty good outcome in my book.

Hopefully from what I have written above, you can see the benefits of having a budget. The only one capable of making a change to your personal financial situation is yourself. This can be difficult to do initially as for many people some of the concepts involved are foreign to them. Once you have started however and begun to see the results, I am quite confident you will never go back. To reiterate what I said initially, the single biggest thing you can do to improve your own situation is get your spending under control. You can pay a financial adviser or other professional as much as you like, but it you don’t spend less than you earn, there is very little they can do for you. I’ll speak more on this in subsequent articles.