Budgeting 101 - Post #7 in the series CFO of Life

I remember my first experience making a budget. It was quite a few years back when I was little. I think I was in 2nd or 3rd grade. It was part of a simple school exercise of making a budget for your family. The vivid memory that has stayed with me from this is that mum told to me we didn't have a budget. I still wonder how she still doesn't have a budget to this day. But surprisingly, more than 35%+ people don't have a budget!

What is a budget?!

It's a plan that looks into how much you can spend and how much you plan to save. It’s the monthly/weekly review of your financial performance.

How to set up a simple back-of-the-napkin budget?

Firstly, you’d need to know relatively how much income you have (per month) and how much expenses you have (for the month).

Secondly, decide what you want to optimise for – minimum expenses or maximum savings without suffering big drawbacks.

Thirdly, choose if you want to view it as a $ value or a % of your total income.

Finally, set a plan for how you’ll achieve this. If you want to decrease the $ value, then you need to reduce spending. But if you want to increase the % of your savings, you can always try to increase your income while keeping all other expenses fixed.

Advanced types of budgeting

1. Section by section:

This type of budget focuses on category-specific spending. The aim is to allocate a % of your expenses into a category and closely monitor them

2. Deep dive or line by line:

This one builds on the previous approach but takes it to another level. It goes into subcategories for you to allocate expected expenses into.

Example:

Category: Food --> Subcategories: Groceries, Restaurants, Takeout

3. Kokeibo – the Japanese accounting system (the method that I also use)

This is one of the most thorough budgeting approaches that you can adopt before starting a fully-fledged accounting practice. It includes all the above systems and adds expense tracking for more depth of control! (More on this in two weeks)

And as I thought it would be pointless if I only talked about best practices – here are some of the top budgeting mistakes people make:

1. Not having a budget

It's better to have and not use a budget than to need one and not have it. Some people do get to the point of not needing a budget ‘per se’, but to get there you already need to have your finances in order.

2. Under optimising your budget

A simple budget goes a long way, but you still need to have some details. I’ve seen people decide on a random number and then get frustrated at the month's end as they didn't reach their goal. To avoid that, I would suggest spending a bit more time to add some substance when preparing your budget. Then review it every month to see what worked and what went wrong.

3. Over optimising – ‘Analysis paralipsis’

I’ve seen people go over every little detail time and time again without changing anything. Then they get bored as the process takes them too much time. To avoid this, try to set up goals and priorities. After reviewing all expenses, calculating your True Hourly Rate (link at the bottom of the article), ?setting up new plans, or whatever your priority is – step back and come back again next month.

4. Not budgeting for unexpected spending (advanced)

A safety cushion is one of the things that most people don’t budget for. That’s why many have problems with sudden bills and unexpected expenses. But if you have that safety cushion in your budget, it will make the surprise a lot more palatable. And if you don't use it, it will increase your savings at the end of the month.

My cushion is 5% of my monthly income. It’s a small number, but it works for me. That might not work for someone with a larger family or someone who doesn't have any savings.

To conclude, if you don't have a budget – Make one! You’ll thank me later.

If you have a budget, I'd love to hear from you. How did you set it up? How frequently do you review it? What is your acceptable deviation?

If you like my series of articles that teach you how to become the CFO of your Life, like, share or leave a comment with feedback or topic suggestions.

#si #personalfinance (Post #7 in the series CFO of Life)