The term ‘budget’ has almost become a buzz word. It feels as though it’s spoken about every week in the media, whether in politics or some news article regarding the current housing affordability issue. Despite what Joe Hockey says, it’s not as simple as “get a good job that pays good money” to improve your financial position or buy your first home. Being able to construct a well thought-out budget however is key, it sets the foundation for a solid financial plan however it’s not a skill that we’re really taught how to do well. I’ve put together some concepts that should help you navigate through the process of putting together a realistic budget, helping you understand your current financial situation and effectively manage your personal finances.
The 50/20/30 Rule
Starting a budget from scratch can cause a few headaches. We often start without having any idea how much we spend on different aspects of our lives other than our weekly rent or mortgage repayments. This is where a great concept of 50/20/30 detailed by an American company LearnVest comes into its own. They suggest that you should be spending around 50% of your salary on essential living expenses, 30% on your social life and entertainment and retaining 20% for your savings providing a benchmark for three areas of your finances. The breakdown of expenditure does provide a really neat entry point for people to consider their personal budget however they are certainly not hard and fast rules. As much as you should try to avoid putting yourself under financial stress by spending much more than 50% on living expenses sometimes your personal circumstances just don’t allow for less. If you do find this to be true, my suggestion would be to firstly review your living expenses and identify if there’s any area that you could change, and if not then reduce the amount being transferred into your savings and entertainment accounts equally. For example, if you found your living expenses to be 70% you might aim to save 10% and retain 20% for social activities.
The important lesson here is use the numbers as a starting guide and tweak the breakdown so it works best for you, allowing you to pay your bills and get as close to saving at least 20% as possible.
Establish Your Goals
The most important step of any financial plan is to establish SMART goals. If you’ve already been pro-active and set yourself some personal targets it’s always a great idea to revisit them whenever you have the chance. As we journey through life we change as people, and our goals evolve with us. Setting targets for future satisfaction creates the motivation to resist immediate gratification of consumption spending and keeps our focus on our future self.
Through the process of establishing our current SMART goals you will also gain a greater understanding of the financial commitment required to achieve them. Does a savings plan of 20% provide you with enough funds to complete the goals that you really want, and if not would you sacrifice some of your social budget to do so? Once you’ve identified what you want to achieve you can begin moulding your budget to fit your own lifestyle.
Plan Your Own Budget Session
One of the hardest things about completing a budget is probably motivating yourself to find the time to sit down and work through all the numbers. Budgeting is definitely not the most sexy Saturday night activity that you’ll ever take part in but it’s definitely worth-while blocking out a quiet weekend when there are no distractions around you to sit down and get your finances in order. Putting together a great budget isn’t simply estimating a few regular expenses, you will need to dedicate a few hours to filter through your records and bank transactions to get a decent understanding of your spending habits. If you’re a part of a couple that’s living together and have moved onto the stage of building a life with one another it’s really important to do this together. Whilst there are many different ways to run your finances to be successful they shouldn’t be separated at this point. Planning how to manage joint finances can be a difficult topic to navigate, particularly in relationships where one member earns a significantly larger portion than the other and I’ll touch on this in a later post however the core principles remain. As a couple you should be spending around 50% of your joint income on living expenses and still saving 20% of your combined income.
Pro tip: Something that a lot of people forget about are the one-off expenses that occur each year. They sneak up on us and can make life tough so be sure to include an added monthly amount for things like your car registration, insurance premiums and other annual fees. These one-off expenses need to be built into the budget to make sure when it comes time to pay them there is enough residual cash in the bills account to cover their cost. It’s wise to build in an inflation cost of 5% on annual figures each year just to make sure you aren’t going to leave yourself short when it matters.
I’ve included a quick table of suggested expenses below to help you get started however your financial expenditure is going to be unique to you:
Build An Emergency Account
Having an emergency account is the best thing that you can do for your financial future. Many people talk about an emergency account as something to cover the costs of unexpected events which require immediate cash such as redundancy or medical issues that would otherwise mean you need to borrow funds or use credit. My personal view on an emergency fund has far greater reaching power for personal success. Having an emergency stash of cash for all occasions where you need fast access to a reasonable amount of money not only allows you to support yourself through unexpected costly events, it also allows you to act on opportunities to grow your wealth or invest in something that you’re passionate about at very short notice. Obviously it’s important that the funds are not frivolously allocated to speculation investments but having an emergency fund allows you the confidence to try new things that would otherwise be unaffordable. According to ‘The Barefoot Investor’ (who refers to this as his ‘Mojo’ fund) a good amount to have set aside as a pure emergency fund is three months’ salary. I agree with the three month figure, but be on the lookout for opportunities where you can leverage this cash to create personal growth, just make sure that you build the funds back up as soon as possible whilst also retaining your ability to achieve your goals.
Track Your Spending
Technology is sweeping through the financial planning world like a thunderous storm and one of the great additions for budgeting are cashflow tracking tools. There are a number of great apps that exist in the marketplace now that allow you to securely link your bank accounts which feed in data from your transactions. The data is controlled by a powerhouse company called Yodlee which has an exemplary security record. The data provided from your bank transactions allows the app to read the transactions and give you the ability to categorise all your spending into different key areas. The technology is smart enough that it automatically recognises some common places and allows you to set rules for others so that when you return it knows exactly which category the money should be allocated.
Pocketbook is a free app which I currently use myself and although it’s not the most sophisticated app that exists it’s more than enough to get a feel for your overall spending habits and in particular focus on the three different areas that I’ve identified. The reporting is also a little substandard so if you would like to get a little more complex with your own cashflow you can try other products like Pocketsmith or Moneysoft. For example, by entering your upcoming budget into Pocketsmith it can forecast into the future and tell you exactly how much it thinks you’ll need in your account to pay your bills. This is a great feature as it allows you to plan how much needs to be retained in the living expenses account without ever having to worry about the large expenses because you’ve already planned for them.
Another of my favourite apps which is interestingly moving into this space is Acorns. A smart little investment tool which allows you to save a portion of your expenditure from each transaction on a linked card as well as cash transfers in low cost ETF (Exchange-Traded Funds) portfolios. The beauty of this app is that it combines the ability to save money and track your spending habits with a gentle introduction of the highs and lows of share trading. By utilizing a portfolio rather than a high-interest savings account you have the potential to increase the return on your savings albeit with some added risk.
A topic which I will expand upon in another post is the comparison between an investment fund as found in Acorns compared to sitting your funds in a high-interest savings account however just to give you an idea of the difference that a portfolio can make I’ve included a comparison below between each option with an initial $10,000 investment with $250 weekly investments over 20 years. The final $ difference was just shy of $60,000 in total so if your long-term goals are slightly higher than you can save then perhaps this is an option for you. It is important to remember that most likely, the greater the potential return the more risk involved in the investment option.
Re-evaluate Your Budget Regularly
Just like your goals it’s important to constantly keep re-evaluating your budget each time there is a noticeable shift in your circumstances. The change doesn’t need to be massive, it might just be that your boss has rewarded you with an extra $5,000 per year but it’s enough that you should be making sure that it’s allocated properly. A great budget will continue to evolve as your life and finances do, so make sure that it’s reflective of where you are currently at with your personal cashflow.
Hopefully I’ve given you a good starting point to get your budget underway. Each and every person’s situation is different so if you have any questions that are more relevant to your unique situation then touch base and we can talk through some different scenarios that might be more applicable to you. If you liked what you read, share it or leave some feedback so I can improve the material for next time!