““A small leak can sink a great ship”
What is a budget?
The word ‘budget’ has many negative connotations. It is one of those words that make us squirm. It brings feelings of living cheaply and not getting to enjoy life. It’s no wonder budgeting is one of life’s least enjoyable tasks. Tip: instead of budget, try naming it your ‘spending plan’. Doesn’t sound as constraining right?
If we want to get ahead with our finances, budgeting is very first thing we must do. No exceptions. Before we can even set our financial goals, we need to know what we are currently spending and what we plan to spend. If we don’t know our start point then it is very difficult to find the end.
The purpose of a budget is to find out where there are areas of wastage, so reductions can be made to optimise our money so that we can hit our targets. Whether that is investing in shares or saving for a house or any other target we may have. By wastage I mean unnecessary things that stop us from achieving our goals.
A budget is a list of things that we spend our money on. No matter how small, it should be on our list. If it is an annual expense such as insurance then it should be there. If it is just an anticipated one-off expense such as a dental visit then that counts too. If our car is 10 years old, chances are we will need to set aside some maintenance money there. EVERYTHING.
Before I awoke to the importance of budgeting, I had no idea how much I spent. All I knew was I was living well but didn’t have much money left over at the end of my pay cycle. I was eating like a king dining out 5 times a week, socialising and going on vacations. Budgeting, or putting a control on my spending wasn’t exactly my priority.
There came a point where I thought I want to buy a house someday and that wouldn’t happen if I didn’t have money. Houses aren’t free in case you haven’t heard. I had to either find a job that would substantially increase my income, or cut my spending. Cutting the budget became the easier option for me. First, I had to figure out where all my money was going.
HOW TO SET A BUDGET/SPENDING PLAN
The first step is the hardest part, both physically and mentally. It requires us to gather at least 3 months of expenses from all our bank accounts and credit cards statements. Then we put each expense into a named category, such as transportation, entertainment, housing, presents, travel and so on. Don’t forget about the irregular expenses such as vehicle registrations, house repairs, dentists and gifts.
This experience is quite an eye opener. “I spend how much on food!?” I really had no idea how much I was wasting until that moment. It was quite the epiphany.
Once we have our expenses neatly tucked into categories then we can see how much we are spending every month. Hopefully it is less than our income! We can also see which categories are the highest and which ones will be the easiest to cut some fat from.
When deciding which expenses to cut, always refer back to your goals and values. Wanting to achieve certain goals such as saving for a wedding or a house are what prompt a budget in the first place. But also consider your personal values. If you value your holidays with your family then that should stay in the budget if possible. By prioritising budget items by importance, we still get to spend on things that you value most in life.
The point of cutting expenses is to remove the expenses that will cause the LEAST pain to our lifestyle. It really isn’t about deprivation. In fact, a good budget will leave us gaining more than we are losing out on. In case you haven’t picked up on already, I love food. I made some good reductions to my food budget but I would never cut it down so low to the point where I felt deprived. I have found a happy medium. Whereas Sky TV was easier to ditch. I thought I would miss it greatly but I haven’t. In fact, losing Sky TV has allowed me more time to work on more productive things such as my business, studying, volunteering, reading books and spending valuable time with loved ones.
So, you can see that although it may feel like we are losing something, by reducing clutter and simplifying our spending we may end up gaining more than we bargained for.
The three biggest expenses for most people are housing, transportation and food. If we can find room to cut back on one or all of these then the impact on reaching our goals can be substantial. Can we go from two cars to one? Can we live in a smaller house or a cheaper one that is further from the city? These are not easy decisions to make and are not for everyone. Only we can decide if the sacrifice is worth it.
The next expenses I recommend paying attention to are monthly expenses. Recurring expenses such as electricity, internet, gym memberships and insurances provide an opportunity to make permanent reductions to our spending. There are a lot of service providers that want our money. When your contracts expire, shop around and see who can offer the lowest rate. I recently cut $250 a year off our power bill by changing company. Don’t be afraid to change companies, otherwise they have a habit of increasing our rate automatically every year. The good thing about cutting monthly expenses is we can often keep the same level of service but at a lower cost.
Don’t forget the smaller expenses. No, cutting coffee and avocados won’t help us buy a house in 5 years. But they can add up over our lifetime.
I always recommend leaving a bit of room in your budget for ‘miscellaneous’. Things happen in life that we don’t plan for and being conservative with our numbers is a good idea. Don’t get upset when you go over budget. I do all the time. It happens. We go through times when all expenses seem to come in at once. Dishwashers break down or we need new fillings. Then other months we will go under. Expenses don’t occur in a straight line.
My monthly budget estimates spending of $2,200, but I NEVER hit the target. Some months I go under, other months I go way over. I don’t let that discourage me though. I just stick to my plan as best I can.
I HAVE SET MY NEW SPENDING PLAN, NOW WHAT?
Input your new spending plan by giving every dollar a job. There are plenty of apps available for download such as YNAB or Mint. Or if you are old school like me you can start an excel spreadsheet. Read to the end and you can download a copy. Enter your estimations for each category and as you spend on a category enter that into whatever recording method you are using. If you pay by card then you only need to go online once a month to get your totals for the month. 10-15 minutes work.
You can see how you are tracking at any stage and if you need to pull back in any areas. I can’t stress this enough, but it is fine to go over budget. The main thing is we are focused and genuinely trying to make targets. Please don’t let the numbers over consume you. The point of a budget is to free us, not burden us. Don’t get too hung up on the exact numbers.
The first time you set a spending plan you will be consumed, but this is only because it is all new. Once it becomes a habit, things will become automatic and you may find you don’t even need to continue budgeting.
DETERMINE YOUR OWN METHODS
Speaking of automatic, I suggest having as many expenses as possible set up on automatic payments to come out the same day as your pay if possible. Much like Kiwisaver, the money that goes out before we even see it is a very powerful thing. We get used to not having it and are not tempted to spend it. If we want to save money, making our savings automatic are a great way to reduce our income, thus reducing our spending. If you are in Kiwisaver, think about the money you invest. If you are like me, you won’t even miss the money because it becomes an automatic habit that needs no action on our behalf.
When our budgeting becomes automatic, we get to a point where we don't need to budget anymore. Maybe just an annual check up. Just like anything, when we get good at it, we don't need to spend so much thinking about it. Think back to when you first learned to drive. There were so many things to think about competing for our attention. It is hard for our brain to process so much information. Starting a budget if you haven't done one can also feel like this. But don't give up, and just like driving a car we can almost do it without consciously thinking. It is now part of our subconscious, leaving us more time and energy to focus on something else.
Another method you may decide on is the cash envelope system. This is a system suitable if you have trouble saving money. It is simply paying for everything by cash. At the start of the month you will put how much money is in your budget for each category into an envelope dedicated to that category. When you need to spend money on a category, you take the cash required from the relevant envelope and spend it. The theory behind the cash envelope system is it is much harder for us psychologically to part with cash than it is swiping a card. When swiping a card, it is sometimes hard to connect it to the cash value. Cash leaving our hands hurts us more. You will need to feel comfortable carrying cash though, if using this method. It’s also fun watching the cashiers activate the EFTPOS terminal, and then cancelling once they realise you have cash. They look at you like you are from the stone age.
Another option may be to focus on reducing one expense at a time. Once you master that then you can find another expense that you can reduce. This method is great because the method of changing our WHOLE budget for the first time can be overwhelming. Breaking it down into more easily identifiable goals can make the process easier. This way we will probably be less likely to give up because it all seems to difficult.
These are just a few examples of how to implement a spending plan, but you can come up with any way that works best for you. What works best for me will not necessarily be the best method for someone else. Find your method.
FINAL THOUGHTS
A budget spending plan is an invaluable tool to help us prioritise your spending and manage our money. We can more easily identify wasteful expenditures that are getting in the way of you achieving our goals. If we want to achieve progress in the shortest amount of time possible then we will need to focus on the big 3 – housing, transportation and food.
Everybody wants a slice of our money. It is up to us to protect it. Only we can tell it where to go. Having a spending plan is about making choices. Tough decisions will be made. If we want to improve our position, we will need to learn to say no sometimes.
The key thing that guides our decisions should be thinking about why we are doing this and how much do we want it. If we don’t want it badly enough then that is fine. Just make sure you are honest with yourself and bear in mind if we don’t mind our money early in life, money will always be on our mind until the end of life.
The more we want it, the more we should be willing to make cuts and sacrifices. The more we want something, the more we should be delaying gratification. How much we cut from the budget depends on how much we want to achieve a particular financial goal. Large cuts to spending are not for everyone. Find your level or balance of future vs present needs that works for you. Find that point that both makes you happy and helps you to achieve your financial goals.
A spending plan should have some ‘fat’ in it, so you don’t feel guilty for small lapses. It happens to us all and it is unhealthy to always fight our urges. Our budget shouldn’t be cut to the bone so tight that it is all we can think about. A good budget will be challenging for the first 6 months, but not so challenging we become miserable. We don’t want our budget so tight that we miss out on some of the most wondrous things in life. If we haven’t budgeted for a dog, but our young family really wants a dog, we shouldn't let your budget dictate this. Our biggest wants should be in our budget. Our smaller wants should be cut.
Don’t think of a spending plan as something that is limiting or you will struggle to convince yourself it is worthwhile. Instead, think what you are gaining from it. That feeling of being free from living paycheck to paycheck. Or reducing the length of our mortgage so we can retire in style. Or saving enough to go on that world trip we always dreamed off. There will be many sacrifices we make to get to these targets, and times when we stray off course, but if we can steady the financial ship from sinking it will be well worth it.
If we stick to spending on what we value the most we will find that we are actually not missing out on much at all.
The power generated from knowing exactly how much money we have and where it is all going is a state of financial clarity that frees our time to focus on more important things in life and not stress where our next dollar is going to come from.
****Congratulations on making it to the end. As promised, here is an example budgeting spreadsheet (Excel) that I personally use. In the first tab labelled 'budget', just enter your expenses in the purple cells. This is a prediction of future expenses. At the end of each month or year you can enter your actual expenses in the 'tracking' tab in cells G3 to R37 in the relevant month. At the end of the year you can see your results against budget in the last 3 worksheets. ****
The information contained on this site is the opinion of the individual author(s) based on their personal opinions, observation, research, and years of experience. The information offered by this website is general education only and is not meant to be taken as individualised financial advice, legal advice, tax advice, or any other kind of advice. You can read more of my disclaimer here
Please comment below. What methods do you use to cut down spending? How do you record your budget?