Yesterday, in part 1, we covered the basics in planning your financial freedom, and now it’s time to get a little more involved and look at drawing up a budget and then how to go about sticking to that budget!
You might need to read this more than once, it’s long, but it’s critical information, so perhaps make yourself some coffee, I’ll wait for you, and then we can get started …
When wanting to draw up a budget, there are essentially two main categories that one looks at: income and expenses. The idea behind a budget is to have a plan every month of what your income is and what your expenses are, and then make sure that expenses are less than income (I know this sounds a bit simplistic, but you’d be amazed at how some people struggle with the concept).
Generally, you would start with income, and then work out your expenses based on that. This is because, for most people, their income is defined and they have a fair idea of how much it will be for the month. For the entrepreneurs among you, it is quite possible to define your expenses first, and then set about earning the income required, but that’s an approach to write about another day!
So, here’s a step by step approach to drawing up a budget:
1. Pull out a piece of paper, and write down your income at the top of the page.
This is what you bring in every month, and what you spend has to come to less than this amount. If it doesn’t, you’re living in debt, and heading for bankruptcy down the line.
2. Underneath that, write down your monthly expenses.
Don’t write down any actual numbers yet, just take 10-15 minutes thinking of everything that you would spend money on in a month, and putting them down on the paper.
3. Categorise your expenses
This is an important step, and will help you decide when faced with decisions on what to spend your money on. Next to each expense written down in step 2, write down which of the following categories the expense falls into:
- Basic human needs (what you need to physically survive – shelter, food, water, rest, etc.)
- Basic ‘societal’ needs (what you would be paying for if you live in the real world – car/transport, fuel, insurance, retirement contributions, tax, electricity, basic clothes and toiletries, etc.)
- Nice-to-haves (what makes life worth living or creates some sense of balance – basic entertainment, eating out, smart clothes, etc.)
- Luxuries (always nice, and always a treat, but can easily live without them – expensive gadgets and accessories, holidays, luxury clothes, extra entertainment, expensive cars, etc.)
4. Put down your ideal spending allocations
In a perfect world, this is how your income would be split. This will vary from person to person, but there are basic guidelines which are generally regarded as prudent. For example, spending more than 25-30% of your income on accommodation (rent/mortgage payments) could be seen as excessive. Likewise, spending more than 20-25% of your income on car payments or transport is not smart either, if you can help it. In my mind (and this is just my opinion) my ideal after-tax allocations would look something like this, in this order:
- Savings/retirement contributions: 10-20%
- Accommodation: 15-25%
- Food: 10-15%
- Transport: 10-20%
- Insurance/utilities: 10-20%
- Entertainment: 5-10%
- Other nice-to-haves: 5-10%
- Luxuries: 5-10%
5. Now write down what you ACTUALLY spend
This can be a difficult one, as you may not have an exact idea of what you spend month-to-month. To get a firm idea, carry a small notebook with you at all times, and write down everything you spend on a day-to-day basis. When I say everything, I mean EVERYTHING – from the groceries, to fuel for your car, to those drinks you had with your friends, to your morning coffee, to the small change you put in that charity box. Another way to achieve this is to keep the slips every time you spend money on something – still keep the notebook, but just for those things you don’t get slips for. Then, after doing this for a month, go through your bank statement and add all of your monthly expenses (such as loan repayments, insurance, pension deductions, etc.) to this list.
6. Compare what you actually spend to your ideal spending allocations
I’m sure you’ll be unpleasantly surprised! Identify how much of your income is being spent on nice-to-haves and luxuries. If you’re battling to pay your rent, but you’ve gone out with your friends twice a week, you’ve got your priorities wrong. Or if you have no provision for savings and retirement, but you’re driving the latest model car, you’re also setting yourself up for a problem. Have a long, hard look at the differences between what you should be allocating your money to and what you actually do.
7. Put savings into your budget
If you’re not putting aside any money for savings, for a rainy day, or for your retirement, the best time to start is now. Today. You’ll notice that in my budget breakdown, it’s the first item on the list. I believe firmly in paying myself first – I’m essentially making provision for my future before I spend a cent on anything else. As fit and healthy as you feel today, you won’t always be able to work, and you’ll need an income to live off of when you can’t. The alternatives are working forever, sponging off your family, or living off the state – none of which are terribly appealing.
8. Write down what your goals are
Once you’ve written up a budget (see the next step), you’re going to need a reason to stick to it. Many people draw up budgets, but fail to stick to them, and quickly fall back into their old ways. To stick to your budget, you need to have a goal – a reason for wanting to do it. It could be anything: you want to start providing for retirement; you want to pay off your debt; you want to stop the sleepless nights worrying about your finances; you want to save up for that amazing holiday/car/TV/mail-order bride. Whatever your goal is, write it (or as many as there are) down on the paper with your budget. Every time you start to feel despondent or restricted, pull out that piece of paper, and remind yourself of why you’re doing it. Picture yourself enjoying the rewards of your discipline (cruising down the coast in a convertible in your retirement, or watching a movie on your massive flat-screen a year from now), and you’ll bring yourself back in line.
9. Now write down what your budget will be from now on
You’ve had a look at what you spend your money, and where you should spend less. Now write up a budget that’s realistic, is in line with your goals, and applies your income to your basic needs first, steadily escalating up to nice-to-haves and luxuries if there is any money left over. Take your time, you don’t need to rush it. Chat to your family, friends, and colleagues, and ask them whether they have one, what criteria they use, and how it’s working for them. Ultimately, you want to have a solid idea of what you make every month, what you should be spending, and what’s left over. Then relax and give yourself a pat on the back, safe in the knowledge that you’ve taken some more control over your finances!
10. Check and update it regularly
As your circumstances change, so will your budget. Commit to checking your budget regularly, and comparing it to your current spending levels. It’s a flexible tool, and can be updated whenever the need arises. Personally, I go back to mine every 6 months, but how often you do it is up to you…
Good luck!
As you know, this 3 part series is written by Gareth, if you’re interested in learning more about your personal finance, you can get hold of Gareth on www.goodadvice.co.za by filling out his contact form.
Recent Comments