We kicked off our “Financial Planning”
series last week with a general overview
of financial planning. This week, we are putting budgeting under the
A personal budget is your own spending
plan. It is necessary for a myriad of reasons. Budgeting helps you spend less
than what you bring in. It helps you identify problem areas, such as excessive
impulse buys. It helps you prioritize your spending and manage your money. It
also helps you keep track of your financial goals: are your savings progressing
towards your short-term and long-term goals?
In spite of its importance in a solid
financial plan, many people avoid budgeting. The word is unfortunately
associated with deprivation and frugality. But a good budget means living well
rather than living poor. A good budget, like most aspects of life, requires us
to create balance.
Before crafting a personal budget, we first
need to differentiate a want vs. a need.
Imagine three buckets. Bucket #1 is for
compulsory expenses, such as food, rent or housing, and “overhead” costs like
utilities. Generally, bucket #1 is categorized under fixed expenses and there
shouldn’t be too much fluctuation of cost between months.
Bucket #2 is where you drop your
investments and savings. Bank deposits, retirement funds, property investments,
bonds, and stocks all belong to this category. Lastly, Bucket #3 is for
discretionary spending, such as travel, shopping, hobbies, and nights out.
It’s easy to guess which are “wants” and
which are “needs” isn’t it? Bucket #1 and Bucket #2 contain “must haves” while
Bucket #3 contains “nice to haves.” While items in Bucket #3 are mainly “wants”
and “nice to haves,” you still need to moderately indulge in them to live a
happy, balanced life.
We also need to learn how to separate
personal assets and liabilities. Assets include your house or your apartment,
your vehicles, your checking and savings account, and your investments.
Alternative investments such as art and jewelry also count.
Mortgage and car loans are liabilities, but
will be considered assets when paid in full. Credit card debt and personal
loans tread on more dangerous territory, as their interest rates are high and
they don’t become assets when paid in full. Also, beware of indulging in too
many “wants.” Eventually most of them depreciate to nothing, becoming sunk cost
– when the money could have been used to purchase assets.
On to business. Let’s discuss the three
steps of budgeting:
Start by tracking your spending
There are many ways to
keep track of your expenses – there is no correct method. You can use a
notebook and pen, a Word doc, an Excel spreadsheet, or even personal finance
apps like Mint and Toshl Finance. What matters most is consistency.
Note down all your
spending, even small ones like your daily latte – the point of this first step
is to know where your money is going. Update your budget daily so you won’t
forget anything. Use accurate descriptions for your purchases, such as
groceries, clothes, etc. Again, you want to know exactly where your money is going.
Tracking your spending is
essential as it helps you identify problem spending areas and readjust your
priorities. It also helps you tailor your own spending ratio.
Analyze your expenses,
prioritize, and create a spending ratio
Remember the three
buckets? Most of your income should go to Bucket #1 (Compulsory Expenses) for
food, lodging, and utilities. Try to achieve a good balance between Bucket #2
(Investment/Savings) and Bucket #3 (Discretionary Spending), especially if your
notes on expenses show you are overindulging. Spend less on “wants” and think about
your future financial goals without severely depriving your fun.
Figure out a ratio for
where your income should go. This
Forbes article suggests a 50/20/30 ratio for Buckets #1, #2, and #3. Meanwhile,
a Google search
of “personal budget chart” shows many different approaches to personal
budgeting. The key here is to find the ratio that works for you. It is you who decide what your
Can’t calculate a ratio?
Don’t fret. Just try a ratio combination and see what fits your personal
expenses and needs. Make adjustments if you need to.
Track your budget overtime
Now that you’ve created a
budget, here comes the most crucial step: sticking to it. Do your utmost to
follow the spending ratios you’ve set up – with an emphasis on reasonably
saving and investing your income. You can only gain the benefits of a personal
budget if you track your progress and make sure you are spending below your
income. Your budget acts as a progress report: are you prioritizing well and
If you find it difficult to
stick to your budget, you may be spending too much on unnecessary items –
remember future goals like owning your own home! Conversely, you may have only
started budgeting. In which case, relax. You’ll see quite a difference in your
spending habits in three months and even bigger changes in six months. Just
stick with it.
Want to start budgeting? Click download below to download a budgeting template from www.moneyunder30.com to start your personal budget now.