“My money keeps spilling out like water.”
Many of us have experienced the frustration of having too many expenses to track. We have to pay for housing, utilities, taxes, transportation, food, the list goes on. Sometimes we can’t catch a break despite bringing in a reasonably good income.
It’s normal to feel overwhelmed about expenses from time to time. But when the feeling expands to a paycheck to paycheck lifestyle, you need to start a budget.
A personal budget is your own spending plan. It’s necessary for a myriad of reasons. Budgeting helps you spend less than what you bring in. It helps you identify problem areas, such as impulse buys. It helps you prioritize your spending and manage your money. It also helps you keep track of your financial goals: are your savings progressing towards your short-term and long-term goals?
In spite of its importance in a solid financial plan, many people avoid budgeting. The word is unfortunately associated with deprivation and excessive cheapness. But a good budget means living well rather than living poor. A good budget, like most aspects of life, requires us to create balance.
Before crafting a personal budget, we first need to differentiate a want vs. a need.
Imagine three buckets. Bucket #1 is for compulsory expenses, such as food, rent or housing, and “overhead” costs like utilities. Generally, bucket #1 is categorized under fixed expenses and there shouldn’t be too much fluctuation of cost between months.
Bucket #2 is where you drop your investments and savings. Bank deposits, retirement funds, property investments, bonds, and stocks all belong to this category. Lastly, Bucket #3 is for discretionary spending, such as travel, shopping, hobbies, and nights out.
It’s easy to guess which are “wants” and which are “needs” isn’t it? Bucket #1 and Bucket #2 contain “must haves” while Bucket #3 contains “nice to haves.” While items in Bucket #3 are mainly “wants” and “nice to haves,” you still need to moderately indulge in them to live a happy, balanced life.
We also need to separate personal assets and liabilities. Assets include your house or apartment, your vehicles, your checking and savings accounts, and your investments. Alternative investments such as art and jewelry can also count.
Mortgage and car loans are liabilities, but will be considered assets when paid in full. Credit card debt and personal loans tread on more dangerous territory, as their interest rates are high and they don’t become assets when paid in full. Also, beware of indulging in too many “wants.” Eventually most of them depreciate to nothing, becoming sunk cost – when the money could have been used to purchase assets.
On to business. Let’s discuss the three steps of budgeting:
Start by tracking your spending
There are many ways to keep track of your expenses – there is no correct method. You can use a notebook and pen, a Word doc, an Excel spreadsheet, or even personal finance apps like Mint and Toshl Finance. What matters most is consistency.
Note down all your spending, even small ones like your daily latte – the point of this first step is to know where your money is going. Update your budget regularly so you won’t forget anything. Use accurate descriptions for your purchases, such as groceries, clothes, etc. Again, you want to know exactly where your money is going.
Tracking your spending is essential as it helps you identify problem spending areas and readjust your priorities. It also helps you tailor your own spending ratio.
Analyze your expenses, prioritize, and create a spending ratio
Remember the three buckets? Most of your income should go to Bucket #1 (Compulsory Expenses) for food, lodging, and utilities. Try to achieve a good balance between Bucket #2 (Investment/Savings) and Bucket #3 (Discretionary Spending), especially if your notes on expenses show you are overindulging. Spend less on “wants” and think about your future financial goals without severely depriving your fun.
Figure out a ratio for where your income should go. This Forbes article suggests a 50/20/30 ratio for Buckets #1, #2, and #3. A Google search of the “personal budget chart” shows many different approaches to personal budgeting. The key here is finding the ratio that works for you. It is you who decide what your priorities are.
Can’t calculate a ratio? Don’t fret. Just try a ratio combination and see what fits your personal expenses and needs. Make adjustments if you need to.
Track your budget overtime
Now that you’ve created a budget, here comes the most crucial step: sticking to it. Do your utmost to follow the spending ratios you’ve set up – with an emphasis on reasonably saving and investing your income. You can only gain the benefits of a personal budget if you track your progress and make sure you are spending below your income. Your budget acts as a progress report: are you prioritizing well and saving enough?
If you find it difficult to stick to a budget, you may be spending too much on unnecessary items – remember future goals like owning your own home! At the same time, if you’ve only started budgeting, relax. As time goes on, you’ll see a difference in your spending habits overtime. Check the difference in spending after 3 months. You might surprise yourself. Just stick with it.
A version of this article was uploaded to the blog of our sister company Funding Societies Malaysia here.
This article was written by Funding Societies, Singapore’s leading peer-to-peer (P2P) lending platform. We provide working capital loans for small and medium-sized enterprises (SMEs), along with attractive investment opportunities to the broader public. To learn more about us, click on our website here.