Why is it that BUDGET is one of the most feared words in almost anyone’s vocabulary? In this two-part series, I demystify budgets and show that while you probably won’t stick with your budget, you need one anyway. You really, really need a budget.
Firstly, a big confession: until the first week of January week, I didn’t have a budget in place. Shock. Horror. A personal finance blogger who had NO BUDGET. And you know what? I survived just fine at the time. Having a budget doesn’t mean diddly-squat if you ignore it and spend more than you earn. The key thing is to make savings and investing a priority. I had a commitment to pay myself first through investment, and to recording every dollar (and cent) I spent, so this no-budget method worked just fine – at the time.
But now I really need a budget.
What is a budget, why is it scary and why doesn’t it work?
A budget, basically, is a summary of all your regular fixed income and expenses.
A budget is scary because it involves accountability. It forces you to stop and confront the reality of your spending. Mentally we often think we have more money coming in than we really have, and think we don’t really spend a lot of money. We also don’t tend to allow a buffer in our spending – doing a budget you will quickly see if you are spending more than you earn, or if you are allowing very little for contingencies if something goes wrong.
For instance, say you earn around $100,000 a year. You might think you can spend $100,000 and that you deserve to live in a comfortable means commensurate with your salary. But after income tax, really you would be lucky to have $70,000 to spend. And after fixed expenses such as rent/mortgage, car repayments, petrol, oh and eating food – there isn’t as much leftover as you might think.
The trick when doing a budget is to approach it with a no guilt mindset. Just think of it as writing someone else’s CV: it’s much easier if it is for someone else as there is no ego attached to it. You can always adjust a budget – you can spend less or earn more and in fact, a good budget, will change as your situation changes. As soon as you, say, sign up to Foxtel or Netflix, put that in the budget. If you get a pay rise, put that in as well.
A budget rarely works because our lives rarely go to plan. Odd and unexpected things happen – you get a speeding ticket, or drop your mobile phone, your car breaks down and needs a new part, you spend too much on a night out with friends, or (in my case) you need to do unexpected repairs on investment properties.
And unless you have a stable public service day job like me, you might not have certainty in your income, either.
Some people are able to stick to really controlled spending in line with their budget. In some cases, people should (more on that later). But that doesn’t suit me, and while I have in the past bought software to try to do this, I just gave up. What works for me is two things: prioritising my savings, and recording everything I spend money on.
Why do I need a budget now?
I really need a budget now because my personal and financial situation has changed. You should do a budget anytime there are major changes in your circumstances (e.g. separated, new job, having a child), before you contemplate making a large purchase (e.g. a car), or if you feel that you are struggling to get ahead and can’t work out why. [Note: I do not use the word ‘should’ lightly. I prefer not to use it at all. But please, please do go and map out a budget if any of these things are true for you.]
I recently took over two investment properties from my ex-husband. I have just stopped paying for my youngest son’s childcare (childcare in Canberra is the most expensive in Australia), but I will need to spend more on before and after school care. I am in a new relationship with Neil, he has just moved into my apartment and we are planning a wedding. We are going on a family cruise in October/November, we want to go skiing with my Dad this winter (hopefully Neil’s health has improved by then), we want to fly up to the Gold Coast to see family after our caravan trip over Christmas had to be cancelled, and we want to do some short caravaning trips together. I am keen to go back to Taiwan to see friends and do a cycle trip (once again when Neil is well enough). Oh, and my Neil and I are buying investment properties, and I also want to start investing in shares together.
I wanted to work out if I could manage to pay for all of this while still maintaining my focus on paying off my mortgage as soon as possible.
I made an interesting discovery that should have been obvious – I couldn’t do nearly everything I wanted to do on my existing income. It’s simple maths. Of course, being a believer in abundance and being a frugalista, I know this can change. And being a strong, resilient woman my challenge now is to make that change. But I would be in denial if I thought I could have a big wedding, go on a cruise, a skiing trip, a caravan trip around wine countries, have four investment properties, pay off my mortgage and still have lots of cash to splash around on my existing income.
The little things add up quickly
You know the ad: for only the cost of a cup of coffee a day you could do anything. And that’s really the problem: I was finding that I was leaking money out on all sorts of small things. In my last house, I had a cable TV service I didn’t really need. I was paying for a newspaper subscription of $60 a month when I could read it at work for free. There are piano lessons, swimming lessons, martial arts and chess (with equipment an clothing as well). Doesn’t sound like a lot for each thing, but when you add them all up I found it was a long list.
When you compare your long list of (honest) expenses with your income, then you can look critically at what is not giving you the value for what you are paying for it and you can start to focus.
And if this isn’t enough to convince you, according to The Millionaire Next Door mega-wealthy people have budgets. They use them to ensure that they save at least 20 percent of their income to grow their wealth.
When you need a really strict budget
If you are on a low income and/or you know that your expenses are fairly close to your income, then you might need to follow a very strict budget – at least for a while.
My former bank manager once shared how, when she was raising her children and money was tight, she would work out her monthly expenses and then put the money for each thing into ziplock bags. She would only spend what she had cash on. If, say, she spent less on electricity she could take that money out of one bag and put it in another.
Some people use different savings accounts to achieve the same thing. Do whatever works for you.
How to get out of debt
A budget is essential to getting out of debt, in part because the debt it probably caused by overspending and not being honest about true income. If you are doing a budget because you are facing debt, it is especially important to focus on a positive mindset. It is really easy to give up and feel that your situation is hopeless or impossible. But yet, in this case, your budget is more vital than ever.
I recommend following the method identified in The Richest Man in Babylon. The idea is to live on 70% of your income. You use 20% to pay down debt, and then you save 10% and use it for investments. The idea is to focus on growth and abundance so that you are not bogged down in the negativity of it all. Logically and rationally, you would be much better off sticking to paying off the debt. But our brains rarely work rationally.
In my next blog post I will outline the steps that I took in doing up my own budget.
Do you have a budget? Do you have a preferred budget method? What works for you and how do you finesse it so that it works better?
I gave ‘The Richest Man in Babylon’ to my kids and nieces for Christmas. There’s a lot of good solid concepts in that book.
What a thoughtful Christmas present! When things were bad after my separation, I consciously followed the Richest Man in Babylon path of saving 10%. It was hard at the time, and it would have been easy to ‘wait’ until my financial situation improved. But doing it gave me confidence that I could get ahead no matter what.