Introduction to Budgeting
The budget is the backbone of your personal finances. Without it, achieving your financial goals becomes extremely difficult. To that end we’re going to look at how you can start budgeting effectively so you can get the outcomes you deserve.
Before starting a budget its important to understand your current spending habits and your financial goals. This means you’ll be able to identify areas to free up spending and where you want to put this money going forward. If you need help understanding your current spending habits check out my last post.
Recommended Reading: Learn the first steps to take on your personal finance journey with 4 Simple Ways to Demystify your Finances.
Why Budget?
In the UK the mean household salary is around £36,000 which equates to £2,300 per month after tax (no student loans), and assuming they contribute to a pension scheme. This monthly amount will get used up very quickly by living expenses especially if you are supporting others, hence why a budget is absolutely essential. If you are fortunate to earn more than this, a budget allows you to ensure you are putting your money towards the things you want to achieve or buy. In short no matter your income level a budget is a great way to start taking your finances seriously.
People Not on a Fixed Salary
As a side note if you are not on a fixed salary a budget may seem more difficult to produce however you will benefit from this more than anyone as you need to account for these fluctuations. If you have a base monthly salary and you get paid differently each month due to overtime, commission, or tips use the base pay as your budget then designate where any extra money will go each month. If you do Project work and get paid very sporadically in large chunks try using your annual pay divided by 12 to use as your base monthly income. Either way use a figure that is realistic and correct along the way if you were over ambitious.
The Three Main Areas of Budgeting
Once you’ve got your average monthly income in our case £2000 we can start to look into the three main areas of budgeting: Living Expenses, Savings/investments & Disposable Income.
Almost all expenses can fit into one of these categories please see the table below for some examples:
Living Expenses
These are the expenses that are essential to your life such as housing costs like your rent/mortgage, utilities, food, costs for cars and any other high interest debt. Basically all your monthly bills. We’re looking for a number between 50%-60% of your monthly income after tax.
Saving and Investments
This is the money that you’re putting aside for future you (or kids/grandchildren). This could be anything from a engagement ring to an early retirement fund. The choice is yours, although I usually reserve this section for the big ticket items, house deposits and retirement funds. This should be around 20-30% of your budget.
Disposable income
All the money that’s left after your expenses and savings is your disposable income a.k.a. the fun money. This can be spent on anything you like, go wild (or save more)! This remaining total should be between 15-20%.
Example Monthly Budget For £2000
Category |
Percentage |
Monthly Amount |
|---|---|---|
Living Expenses
|
50-60%
|
£1000-£1200
|
Savings & Investments
|
20-30%
|
£400-£600
|
Disposable Income
|
10-20%
|
£200-£400
|
How to Set Your Budget - The Simple Way:
- Firstly from your monthly take home pay calculate the target ranges for the three categories using the guide percentages above.
- List out all your essential living costs adding them up to find your total monthly spending on living expenses – for now don’t worry about the percentages.
- Calculate your remaining money: Monthly income – Living expenses.
- Divide this figure by two splitting it equally to the Savings and Disposable income.
- Now compare these figures to the guide percentages and your savings goals. You can tweak the savings and disposable income figures as you wish but I always try to prioritise saving.
Recommended Reading: Confused about what personal finance covers? Read The 5 Pillars of Personal Finance.
Struggling with meeting these percentages?
Firstly don’t worry! As stated these are only a guide and so will not fit all people. Your age, responsibilities even where you live will effect these percentages but in my experience its a great place to start. By taking this first step of owning your finances you’ll now know of areas you can improve. Also if your essentials costs are less then 50%, congratulations you’re in a very lucky position!
Reducing your essential costs and any unnecessary costs
Reducing your essential costs means you’ll be able to put the money you free up every month into your savings or your disposable income. A warning though please do not squeeze your essential spendings to a point where you are reducing your standards of living or your health. Optimising this so you find a good balance is essential. Money is a tool after all and the essentials are essential for a reason.
Increasing your income
If you are on your limit and have exhausted all opportunities to scrimp and save its time to look at your income. The obvious way would be to look for a new job or ask for a raise/promotion. Both options are easier said than done.
One way to increase your income could be to upskill or reskill. I couldn’t think of a better way to use your savings in the short term than investing in yourself. By learning the right skills and experience which employers value it improves your chances of increasing your incoming dramatically. It might even inspire you to build your own business. Either way taking the first step is the most important and any money saved or invested in your future is money well spent.
Emergency Savings
The first thing everyone should have saved is an emergency fund. This is for the times when something unexpected happens. Maybe your car gets a puncture, your roof gets a leak or your fridge breaks. You cant predict exactly what will happen but you can bet something will so why not protect yourself with an emergency fund. The usual size of an emergency fund is recommended at 3-6 months worth of your living expenses. This can be a lot of money to save up at the start of your journey but having it safe in the background gives you that security. It also means you can focus on your other savings goals knowing you wont have to dip into them if the going gets tough.
Savings & Disposable Income
Now that you have a figure for your living expenses and an emergency fund this is the fun bit – planning how you’re going to save and spend your money. This part is totally down to you but with my savings portion saving for world travel, a house deposit, and investing are my current main goals. Think about what you want, how much they cost and when you need the money for. Then split your savings appropriately. Creating strong and realistic financial goals is a topic I’m looking to dive into in upcoming weeks.
As for your disposable income this really is down to you. Some helpful tips though. If you are predominantly a saver it is worth reminding yourself that money is there to be spent and its okay to buy nice things every now and then. If you find saving difficult its more about how much you want the things you save. If the goals are strong enough you’ll find when yourself beginning to question every purchase you want to make. Try not to make impulsive purchases either wait a few days and see if you still are happy to make the purchase.
Sticking To Your Budget
One of the hardest parts of budgeting is sticking to it. Its important to see a budget as a positive. Its a plan demonstrating how you’re going to achieve your financial goals. For this reason they are also flexible as all initial plans are likely to have flaws. Don’t feel bad if you have to adjust frequently at the start this just shows that you’re beginning to understand your finances better. Of course these adjustments must have legitimate reasons not just because you want to splurge on the latest new tech.
To keep me on track I like to review my budget annually or if I increase my income. I also have a set pay day ritual which allows me to keep in touch with my budget every payday. Helping me to stay the path.
Conclusion
In conclusion a budget shouldn’t feel restricting. It should help to ease uncertainties in your finance as you know exactly where you’re money is going and will mean you’ll have all your essential costs covered. It should also provide hope as it has been designed with your goals in mind. It gives you a game plan to reach your wildest goals and that should be looked on with unbridled optimism!
I hope this has helped and happy budgeting!
Disclaimer
All information is not financial advice and is purely meant for educational purposes only. Investing involves the risk of loss of capital as well as its gain. Any investments mentioned on this website are meant as examples not specific recommendations. Always do your own research and/or gain the help of a financial advisor.
