A BALANCED BUDGET
Its payday and Heather (age 26) has mixed feelings; joy that she can breathe again and agony that it wouldn’t be for very long. She has been on this emotional rollercoaster since she started as an on-the-job trainee and now manager of the entire unit.
An exemplary employee, Heather’s salary increased steadily every year and now earns $7,500 plus a tax-free allowance of $1,800, with a net pay of $8,300. Heather’s frustration is that she has nothing to show for the five years of her employment save and except a computer, mobile phone and a couple household appliances. She simply cannot explain where all the money went.
Wanting to turn a new leaf she started reading “The Richest Man in Babylon” by George S Clason who said: “A part of all your earn is yours to keep”. When she asked Suzanne (a coworker) about the line, Suzanne asked: “Don’t you do a budget to save?” “Not any more!” Heather responded. “Well that’s why you have no money” Suzanne replied. Heather has tried budgeting before but it was just a huge waste of time as her salary always finished before month end.
With Suzanne’s and George’s words fresh in her head, Heather wants to give budgeting a second chance to establish an emergency fund and have money to buy her own home.
A budget is a plan to allocate future income towards expenses and savings.
Why do a budget?
A properly prepared budget improves Heather’s chances of achieving her goals and ensures she has enough money to meet her needs and some of her wants. She will have a framework for better decisions and stable cash flows. Most people view budgets negatively as restrictive but if it is seen as a savings strategy, sticking to it becomes easier and less painful.
How much to save?
George S Clason and many other financial experts advocate saving ten per cent of one’s income. Whilst this can accumulate a handsome figure over the long haul, I have found that some goals might require different percentages based on their price tags and time lines.
To purchase a home Heather would first need a down payment (10%) plus money for closing costs (5%). Assuming that the house in her future costs say $1,000,000 she would need at $150,000 to get into this market. If she wanted to achieve this goal by say age thirty, to capitalize on a 30-year mortgage, she needs to save $3,125 per month for four years (excluding interest) which is 34% of gross salary ($3,125 ÷ $9,300 x 100%), the average threshold for most mortgages.
If we factor the emergency fund goal of say $30,000 over the same time frame her monthly savings moves to $3,750 or 40% of salary. With a net pay of $8,300, Heather now has $4,550 to budget for living expenses.
Steps to Budgeting
Heather has to think priority when considering the following:
1. She makes a list of everything she spends during a month or over a year to capture the non-monthly expenses. She can gather this information from credit card or bank statements, receipts from purchases, things she habitually purchases, handwritten notes or mobile applications.
2. Everything must be converted into a monthly amount, so bimonthly; quarterly, semiannual or annual expenses must all be divided by the respective number of months.
3. She then totals the monthly figures and if they exceed $4,550 she must make adjustments by reducing or eliminating non-essentials.
4. Adjusting numbers is only a part of the success formula; she then has to come up with a list of strategies that support the changes to her numbers.
Keeping Track & Control
With budget and list of strategies in hand, Heather needs a money management system for the plan to work. The system can include a combination of accounts and payment methods. The following are only a few suggestions:
Envelope System: This requires cash for various expenses to be placed in separate labeled envelopes and funds used as needed to the extent of the cash available in each envelope.
Dedicated Accounts: This groups up expenses either by category such as utilities or by frequency, such as quarterly or annually. A predetermined monthly amount is transferred into each account and funds accessed only for the payment of dedicated expenses.
One Account System: This uses only one account to collect income and disburse using electronic payments, standing orders, cheques, cash withdrawals or a debit card. This account can also be used in conjunction with a low limit credit card that can be cleared monthly to avoid interest charges.
Regardless of which system Heather uses, she should always record each expense so that she can later analyze trends in her spending decisions and make adjustments to stay on course.