Financial Advice 5: Budgeting Basics
Build a Budget and Follow it!
A Budget Doesn't Balance Itself
People, businesses and especially governments all have difficulties balancing a budget. The fundamentals are basic: income should be greater than or equal to expenses. If you spend more money than you receive, you will eventually go broke! Your budget should allow you to save for the future and if you are already retired you should have a plan to make your money last-running out of money in your golden years is the culmination of bad budgeting. Bankruptcy is even worse, it represents the ultimate failure in planning.
Start budgeting by adding up your monthly after-tax income, if you get paid bi-weekly either adjust it by 26/12 or make 12 monthly budgets if your income is not the same month to month. Only count income that is assured, relying on excessive commissions, bonuses or lottery winnings increases the likelihood of failure. If your income is variable, use a conservative estimate such as the average monthly amount over the past two years. It's better to underestimate than to overestimate your income, a budget is personal and you shouldn't show it off.
Once you know your monthly income add up your fixed costs such as rent/mortgage, debt payments, insurance, utilities, and anything else that you have no short-term discretion over. If you subtract your fixed costs from your income you will have your discretionary or variable costs. Some variable costs such as food, personal items, transportation, and clothing are not optional but you do have control over how much you spend. We will talk about that later, for now just set a reasonable limit for your variable costs. Make room for entertainment, you only live once.
Savings and Miscellaneous Items
Once you have your essential expenditures down (shelter, food, clothing, entertainment, transportation), you need to have room left over for Other Expenses and most importantly Savings. Long-Term and Short/Medium-Term Savings should both be included. Saving for your retirement is not optional, saving for short-term things such as a vacation, a car, or another large expense is also important as you probably can't afford these items in your monthly budget. Miscellaneous items can include things you don't need to buy every month like small appliances, gifts, membership fees or cryptocurrency speculation.
Update Your Budget
Keeping a spreadsheet and updating it regularly helps you realize where you are spending too much money so you can save more. After a few months or years, you should be able to accurately predict your budget, save and have money left over to do with as you please. Whenever you have extra money at the end of the month (or year if you are more disciplined), reward yourself by spending half of it and save the rest. The same thing goes if you get a windfall like a raise or inheritance and remember to adjust your budget annually for inflation.
Tips and Tricks
- Think of the benefits from following a budget, not the pain. Do you want to buy a boat, travel or retire early?
- There are budgeting apps and spreadsheets available online that make it easier, sometimes your bank may have an App that can help.
- If you can't make sense of your budget show it to your financial advisor, accountant or someone you trust who seems to be in control of their finances.
- Never use before-tax income, tax is the least discretionary expense you have.
- Move your extra cash to an emergency fund, out of sight out of mind. Having a large balance in your chequing account can be tempting to spend so only leave what you need for the month in there.
- Avoid using credit cards if you cannot pay the balance off every month. There is literally no excuse for this bad habit, credit card debt is very rarely worth it.
If you aren't yet on a budget, I strongly recommend you start one now. You cannot build a financial plan if you don't have a budget and you probably won't be able to build your net-worth or retire if you spend more than you earn. By not budgeting you are only hurting yourself. Even if you are a student you should build a budget, the sooner you are in control of your finances, the faster you will achieve financial freedom.
Thank you for reading, your comments and questions are appreciated.