What is budgeting?
Budgeting refers to the act of planning how you spend your money. Just as how Singapore sets aside budget to address various social issues for different groups of people, individuals like yourself can also allocate different amounts of money to different uses.
How can budgeting help me reach a financial goal?
Having a comprehensive spending plan will help guide you on how much you should ideally be spending on different buckets of items. It allows you to determine in advance whether you will have sufficient money to do the things that you need to do, or want to do.
At the end of the day, budgeting allows you to keep track of your spending such that you can balance your expenses with your income. From there, you will be able to identify and eliminate wasteful spending habits, and see any gaps in your wealth and work towards addressing them.
For instance, if you plan to buy a car in five years, or afford a home upgrade in the next decade, you will need to budget your savings, expenditure, and investments accordingly.
Through this, you may also realise that you tend to spend too much money on certain trivial items. For example, if you tend to drink bubble tea three times a week, you may be spending $5 x 3 times a week x 52 weeks a year = $780 a year. This equates to about three or four good cruise getaways!
How can I plan my budget easily?
Budgeting can sound daunting to beginners, but it need not be an intimidating process. If you are uncomfortable working with excel sheets, you can even write it down on a piece of paper. The purpose of the entire exercise is to map out your cash flow, and you can do it in any way that you are most comfortable with. If pen and paper and calculator works best for you, go ahead! There is no right or wrong way.
There are also free budgeting apps available. In these apps, you can set specific financial goals based on your personal life milestones. Over time, the apps will be able to give you insights to your spending habits.
What percentage of my income should I save, use, and invest?
While there is no one-size-fits-all when it comes to budgeting, there is a general 50-30-20 principle that acts as a good starting guide.
Simply put, the 50-30-20 principle breaks down the percentage of your take home salary into three categories, namely Needs, Wants and Savings.
If you take home $5000 every month, $2500 (50%) will go into Needs such as paying rent or mortgage loans, buying groceries, and more. $1,500 (30%) will go to Wants, such as entertainment which includes going cafe hopping, buying a new pair of shoes, watching movies and more. The remainder $1000 (20%) will then be pumped into your financial goals which can include your savings or investing.
By having a budget framework, 50-30-20, you become more aware of your financial habits and can try to limit overspending and under-saving. For example, if you find yourself spending over the original 30% of your take home salary on entertainment, you can ask yourself if it is really worth it to compromise your financial goals in exchange for short-term satisfaction on non-essential items. If you find yourself overspending on Wants, try cutting down gradually and build a healthy spending habit.
Over time, your goals may change and you can then proceed to adjust the percentages based on your new goals. For instance, you may need to spend more on Needs after purchasing a new home due to mortgage loan repayment. When you have children, you will also need to spend more on their education and for their well-being. This is when you can start allocating your income into more buckets of spending.
By spending less on the things that do not matter that much to you, you can save more for the things that do.
How do I budget?
Simply follow the five simple steps below to budget your expenses.
- Calculate your total monthly income.
This includes your take home salary, and any other income from your freelance work or investments such as dividend payouts and rental income.
- Separate your income into 50-30-20.
You may consider spending 50% on Needs, 30% on Wants, and 20% into savings and/or investments. In addition, be sure to have about three to six times of your monthly expenses saved up as an emergency fund.
- List all expenses.
Look at your debt and all other spending on transport, utilities, food, shopping, insurance premiums and more. Include any allowance given to your parents and children, if any.
- Stick to the budget.
Being disciplined is difficult and is not something that one can get right overnight. Give yourself some time to slowly ease into following the budget allocated. Some months may also differ from others, and you may end up spending lesser than intended. In these scenarios, try to allocate the excess budget into savings or investments.
- Monitor your budget.
See if you are on track by monitoring how well you are following the budget. Adjust your spending according to your own circumstances. For instance, your budget will look very different if you get a pay increment, get retrenched, have more dependents, and more.
What is the difference between needs and wants?
Many have trouble identifying what is necessary and what is not. Needs are the essentials that you cannot do without. They tend to be basic necessities such as food, utilities, and more.
Wants, on the other hand, are things that you desire. Sometimes, wants can be pricier substitutes for your needs as well. For example, you need a blazer for work since it is the standard attire that all employees need to have. However, you want an expensive luxury blazer, and perhaps a few more variants to keep your wardrobe stylish.
As evident, it can get tricky as you try to separate Needs from Wants. As a guideline, you should always prioritise spending on your needs over your wants. Try to recall the last item that you bought. It could be a cup of latte, a new pair of weights, or dinner. Ask yourself the following questions:
- How much did you spend on it?
- Was it a need or want?
- Was the item or service bought on impulse?
- Have you compared prices to see if you got the best deal?
Every individual requires money management skills. These skills help to adopt a healthy wealth building mindset. By asking yourself the questions above, you will learn to spend on and save for your financial goals.
What are some limitations of the 50-30-20 principle?
As with every guideline, the 50-30-20 principle is not without its faults. Some shortcomings include the difficulty of categorising all spending into one of the three groups. For example, you may want to celebrate a loved one’s birthday at an expensive and fancy restaurant. This may fall between a Need and a Want given that it is a special occasion and that you rarely frequent these restaurants.
Another shortfall is that the principle does not consider your income level and personal circumstances. Depending on how much you earn, it can be tough to set aside 20% for savings. For example, you may be the sole breadwinner in your family and is new to the workforce. With limited experience, there is only so much salary that you can command. You may also be earning just enough to cover the family’s basic needs. In this case, the 50-30-20 framework may not work at all. Instead, there may be a need to look at generating more income streams through side hustles.
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