Let’s be honest – budgeting can be a very boring task, and many of us just don’t like doing it. Tracking every expense on a daily basis? Sounds tedious and time-consuming. But it can also be a very important exercise in your life to see how well you know your finances. And you don’t have to do it forever.
Do a small experiment
The main purpose to start doing some budgeting is to allow yourself transparency into what you earn and what you spend – and where your main spends are. So, let’s do a small experiment.
STEP 1: Do an estimate
To get started, you can grab an empty excel or just a piece of paper and estimate your average monthly incomes, your one-off incomes, your average spends in major categories. For example, you will probably come up with some fixed spends, such as home, car, food, education, loans, as well as more variable spends, such as entertainment, investment, clothing, etc. This is your estimate.
Now go ahead and check your budget estimate against your real situation. You can extract data from your bank account, for example, for the past one year, and put in on another sheet of the excel or print it out. Classify every row into similar categories that you used for your estimate. Then filter by types and calculate averages. Now compare the data against your estimate. How close was it?
STEP 2: Check reality
If you are like myself, you will probably be surprised. I thought I know well what I do and usually have a good feeling of money I receive and spend. However, calculating actual data created the real awareness. I’ve tried and never managed to do really long-term diligent budgeting, recording every cent. With this exercise I made some proactive steps to plan my pockets in a more reasonable way, and also put some of the items – particularly investment and savings, on autopilot
Budgeting is your strategic partner
When you start taking your financial planning in your hands, you might quickly find out that you need to do some kind of monthly and yearly budgeting. Many people find it tedious as they have at lease once experienced difficulty to follow any budget restrictions, so they quit it. Instead, try to think about it in a more strategic way. What if this is a way to achieve your goals, get a peace of mind, and find an easy way to navigate your own rules with money? Now, this makes things easier and more achievable.
Get a grip of your finances
If you are now determined to give budgeting a try, let’s look at some ideas as to how you can address it in the most meaningful way. Remember, budgeting always starts with making the current situation transparent, and only then optimising for the future.
1. Model your incomes
If you are on a payroll, earning a regular salary every month, you can just check the last few months’ pay slips and calculate an average amount to work with. Of course, you also need to account for some special bonuses, one-off rewards and so one, so look at specific months from last year and get these amounts more precisely.
If you are self-employed, working on service contracts, and getting variable pay every month, the exercise might take a little bit more time. You will need to look for a longer timeframe. For example, you can take a look at a full year to calculate a monthly average. You might also want check if there are some time-bound variations, that should be taken into account in planning phases.
The last step is to think about any other one-time or irregular incomes – for example sell-offs, revenues from blogs, apps, royalties, etc.
Once you’ve gathered everything, you can model it as regular monthly incomes and also planned one-time incomes, so that you can get your planned inflow.
2. Now, let’s dig into spending
This is probably a more time-consuming exercise and we might even resist the idea of starting with it. So, why don’t we try to change our attitude towards it by putting our detective glasses on, and going on a mission? We are going to find out what are our absolutely needed fixed spends, what are the variable spends that actually make us happy, and how we are saving or investing for things that matter the most in our lives.
Fixed spends first
Let look at the absolutely needed fixed spends. Things like rents or mortgage payments, utility bills, insurances, school fees, groceries, etc. are part of this necessity. While ensuring our living standard and assuming that these are all needed expenses, when we gather them we can look at them holistically and see potential for optimization on a later stage. For now, you can just put them in buckets and calculate the expected approximate amount, so that we can validate our budget.
Now, variable spends
The next category are expenses that are variable but also support our happiness. They might include shopping, entertainment, vacations, education, presents for close people, club fees (fitness, sport, charities, etc.). We definitely want to have some of these, so that we can make our life more meaningful. But also, if we need to change something, this is the category we need to look at deeper.
Savings and investments
Hopefully, you already have a category for savings and/or investments. Make sure you doublecheck it, too. In any case, it is good to look at your account statement for some emotional spends. These are things we bought but actually don’t use, subscriptions we made and planned to do but actually did not follow through, credit card debts that we entered in just because we needed some cash urgently. The sooner we review them and take action to remove them, the more we can put on savings and investments for the future.
3. Analyze your cashflows
Once we listed everything, we can model our spends. Now we can check what the balance of our income and spend is. Furthermore, we can see our cashflows and look for patterns. We can also see projections into the upcoming months. For example, when we might need more money than on an average month. When we know it, we can plan for it and we can also look at our spending with more neutral eyes to check what we can really get rid of.
Here is an example of what a typical balance might look like:
Fixed spends: ~30%
Variable spends: all the rest
Maybe you have heard of movements, such as FIRE (Financial Independence, Retire Early) for people who want to retire early. Actually, it might be more correct to say – get financial freedom early in life, so that one doesn’t need to work after a certain age. If we were analyzing our budget while working towards such a goal, we might need a slightly different distribution. For example, it is very likely that we need a much higher investment part of up to 40-50%. Also, we might need to plan much more restrictive spends elsewhere, so that financial independence can be achieved faster.
Leverage transparency to optimize
Your budgeting exercise has hopefully helped you know where you stand. Now, here are some ideas for optimization, so that you don’t have to continue micromanaging your spends.
Put investments on autopilot
Regardless if you are saving small amounts, or you are looking for early financial freedom, investment is in the category “pay first” – make sure that you pay your future self. It is best if you can automate this step and it is executed without you having to think about it over and over again. Many of the banks and online systems now have such an option. So just check how you can do these regular payment for your future automatically.
Set budget limits for expenses
As we noted, we usually have fixed and variable spends. Once you take care of the savings, the next most important part are fixed expenses. It is probably easier for people on a regular salary, and it is especially important for people with variable income. One easy way is to have “pockets” and distribute your income automatically each time you receive money, proportionally or following some priority mechanism. Having the amount ready when you need to do the payment reduces the anxiety a lot and gives the feeling of successful management.
Reduce credit cards debts and loans
Reviewing them and reducing them is an important step. And an even bigger reward is if you can redirect the freed money into the investment pocket. This will increase your confidence and feeling of purpose.
Review insurances and subscriptions on a regular basis
Take a look at them and ask yourself: do I use this? If I needed it, what is the best price for my needs and can I re-negotiate it?
So, budgeting might be tedious if you look at it from the perspective or restrictions and over-control. Designing your investment, fixing spend pockets, and putting them under control might be your way forward to build a feeling of good financial management. And this goes with less anxiety and more freedom to deal with the variable part for a more enjoyable life.