Everyone will have their own version of what makes a budget work for them. The way I teach budgeting is the way that works for me. It’s not the only way to do business however. I expect that many of you will take away some of the things I say in these articles, and come up with a system that works for you. Even those of you who adopt my system in its entirety will make some changes as they get used to using it so that the budget works better for their particular situation, circumstances and personal preferences. There are a few golden rules to budgeting however, that are applicable in almost all cases. They are as follows.
Spend less than you earn
This is the single most important thing you must understand about budgeting! It is a really simple concept but it is often the one people have most difficulty with because it may not be what they want to hear. You must spend less than you earn. I am going to be very upfront about this and I am also going to be very blunt about it. There is no alternative to this and no way around it. Unless you understand this simple concept and live by it, you will never be financially successful. I want to reiterate this point. You must spend less than you earn. Unless you understand this simple concept and live by it, you will never be financially successful. I want to introduce a concept here that will be used throughout the following articles. It is the concept that I will call your “Number.” Your number is your total income. If you earn $5,000 per month then that is your number and that is all we have to work with. If your expenses add up to $5,500 you are going backwards.
It doesn’t matter how much money you earn, the principle is the same. If you want to borrow money to achieve a particular goal, then we can look at that, but you must be able to afford the repayments. It doesn’t matter what else we do, when we add up all your expenses we cannot exceed your number! If we do, then we need to go back and cut our expenses somewhere. That might mean you can’t go on an overseas holiday every year like you want to, or you can’t buy the new car you want. But that’s where we are at. In the short term we can get around this issue, by using credit cards and personal loans, but in the longer term, it all catches up with us. Every dollar you spend now is a dollar you don’t have to spend later. You must spend less than you earn.
That’s not to say you can’t have any of the things you want. It becomes a matter of priorities. You might want both a car and a holiday. When you do your budget you might see that you can’t afford both. So it becomes a choice for you to make. I am not going to tell you how to spend your money. What you spend your money on is your business. I am simply going to tell you not to spend more than you earn. Another way to look at it is in terms of consequences. It might be a case of “If I buy that new car, I won’t be able to go on the holiday I had planned.” Once again, you choose! Another way to look at it might be that I can’t afford both now, but if I can cut my spending elsewhere, maybe I can have both! You might look at your budget and decide that if you start taking a cut lunch to work instead of eating out each day, then you might be able to afford both the car and the holiday. You can buy whatever you like, as long as it fits within your number! That is where budgeting can be a powerful tool. It helps you make educated decision about how you spend your money. When you start you will probably find that you are leaking money in certain areas. By leaking I mean you are probably spending money you didn’t even realise you were spending. The classic example that is often used is that if you buy two cups of coffee a day and are able to cut back one a day, you can save $1,000 a year. That might seem like a throwaway line, but it’s still $1,000 a year, which could be the difference between affording that new car or not.
Pay Yourself
This might sound like a strange one, but it’s critical. You must allow some money in your budget for yourself. It’s all well and good to say that you won’t go out for the rest of the year so you can afford that holiday, but is that really going to work? If you work unrealistic assumptions into your budget, you are setting yourself up for failure from the beginning. Maybe going out once a fortnight instead of once a week might be a more reasonable sacrifice to make. The important thing is to decide at the start what you think is reasonable to spend on yourself and then run with that. You might find that you have to trim this amount a little to fit in all the other things you want, but you have to give yourself something. The beauty of this is that once you have your budget set up, you can then spend this money and not feel guilty about it. If you have done your budget properly and know that you can spend $100 per week on going out with friends and still meet all your other commitments, and then if you go out and blow that $100, you can do it guilt free. You can spend it on whatever you like.
This concept can be an even more powerful tool for couples in managing their money. One of the biggest causes on conflict in any relationship can be disagreements over money. When you do your budget, discuss how much you think is reasonable for each partner to have for their own and then allocate that amount. Continuing on from the above example, if you decided that $100 per week each is appropriate, then you each get $100 per week to play with. Because each partner has their own money, neither cares what the other spends their money on. If she spends her $100 on clothes and he spends his on lunches at work, it’s not an issue. And if you want something that costs more than $100? Because you now have your own money, you can save towards it yourself. It sounds simple, but little steps like this can significantly reduce the amount of conflict you experience with your partner over money. Whether you’re single or a couple however, remember that you must pay yourself something or your budget will fail.
Be realistic
This point follows on from the last one. Be a realist when you do your budget. If you set yourself unrealistic goals, then you will fail to achieve them! If you know it costs you $200 a week to do your weekly grocery shopping, then saying it only costs you $100 simply means you blow your budget from the start. That doesn’t mean we can’t aim to make some savings by aiming to spend a little less each week. Aiming to reduce our shopping bill from $200 to $180 might be a little more realistic though. Aiming to cut it in half is probably just wishful thinking. The same goes for all your expenses, be it groceries, clothes, holidays or how much it costs you to service your car. If you underestimate the true cost then all you are doing is setting yourself up for failure. It’s better to overestimate to begin with and then adjust down later than to set an unrealistic goal in the first place. If you want to make significant savings, then take it slowly.
If you currently eat out four nights a week, then cutting straight back to once a fortnight is probably a little ambitious. Maybe you could try cutting back from four nights a week to two, and then then once you are comfortable with that then cut back to once a week and so on. It will take you longer this way, but you might actually get there. If you go the other way, all you will do is set yourself an unrealistic goal, fail to achieve it, and then become disillusioned with the whole budgeting process.
Don’t expect to get it right the first time
Budgeting is an imprecise art. It is extremely unlikely that you will sit down once and come up with a budget that exactly meets your needs. For the first few months it will be an evolving document as you nail down exactly how much you spend on each expense. As I mentioned earlier, it’s also better to be conservative at first to give yourself the best chance at success. So if you think you spend $180 a week on groceries, then budget $200 a week initially just to be safe. If after a couple of months you are consistently spending less than this, then you can reduce the amount you’ve budgeted for. The key take away is that at the start your budget will be wrong. You will overestimate in some areas and underestimate in others. Don’t be worried by this, just make the relevant adjustments and crack on. If you’re still wide of the mark after 12 months then you may need to take a serious look at things, but at least initially, it’s ok to be out by a bit.
Additional Resources
There are plenty of additional budgeting resources available online should you wish to read more on this area. The following websites are particularly useful:
Moneysmart – www.moneysmart.gov.au
This is an Australian government website that has lots of different information and tools that can assist you with your budget.
Investopedia – www.investopedia.com
This is an American website that has a wealth
of information on a variety of matters dealing with all aspects of finance, including personal finance.