Personal Budgeting... a start!!!

Reading on from my post on “Financial Planning”, link as mentioned below, came the thought of personal budgeting. Building a budget is essential to creating a strong financial plan.

https://www.dhirubhai.net/posts/pprasannan_financialplanning-money-wealth-activity-6809417921585008640-7LoK

Due to current uncertainty about economic recovery in the aftermath of COVID-19, individuals are bracing for at least a year or two of slow growth, which is reflected in their changed outlook to personal financial matters. The COVID-19 pandemic has spurred individuals to take financial action to save more and to channel these savings into growing their wealth. This will be driven by cutting down on non-essentials, building a financial corpus to dip into during an emergency and by reducing EMI burden.

All of above can be achieved if one knows their finances well; in terms of earning, saving and expenditures. In order to be financially responsible, one does need to have a certain level of tracking. And in order to retire someday, in relative comfort, one need to be saving some of her/his income for the future. This can only be achieved by having “personal budgeting” in place.

Personal budget refers to finance plan that allocates future personal income towards expenses, savings and debt repayment. Past spending and personal debt are considered when creating a personal budget. A budget should have a purpose or defined goal that is achieved within a certain time period. Knowing the source, amount of income and the amounts allocated to expense events are as important as when those cash flow events occur.

It is always advisable to keep personal budgeting simple as it makes person more likely to keep up with it. The purpose of a personal budget is to identify where income and expenditure is present in the common household.

Advantages of having Personal budget

• Planning orientation as it helps you establish your earning, savings and spending.
• Profitability review as it helps you focused on your money goals.
• Assumptions review as it gives you control over your money as you decide in advance how your money will work for you.
• Performance evaluations as it enable you to produce extra money.
• Funding planning as it enables you to save for expected and unexpected costs.
• Cash allocation as it gives your ability to assess potential financial problems an organized boost.
• Bottleneck analysis as it helps you determine if you can take debt and how much.

Personal Budgeting via 50/30/20 rule

The 50/30/20 rule is a way to allocate your budget according to three categories:-

• Needs.
• Wants.
• Savings.

The 50/30/20 budget rule is a simple and intuitive plan to help you reach your financial goals. You allocate 50% of your after-tax income to needs, 30% to wants, and 20% to savings and debt repayment.

Why 50/30/20 Budgeting is best?

• Simplicity: - It's simple to set up and easy to maintain.
• Flexibility: - It can be adjusted to suit any kind of lifestyle and hence it works for anyone.
• Delivers: - Once implemented properly it will help you spend less, save more, and reach your financial goals faster.

How it works?

50% of your after-tax income should be spent on needs: -

• Housing.
• Groceries.
• Utilities.
• Insurance.
• Car payment.

If you add up all your needs and it totals more than half of your after-tax income; then you either need to look into your budget and make cuts or you will need to increase your income.

30% of your income should be spent on wants:-

• Dining out.
• Shopping.
• Entertainment.

Make sure at the beginning of the month you write down your budget and know exactly how much that 30% is. Keep track every time you purchase something that isn’t a need so you can make sure not to overspend beyond the 30%. To remove confusion between identifying “needs” and “wants” refer to table as mentioned below:-

20% of your income should be your savings:-

Budgeting experts differ on how much they recommend you should be squirreling away, but they all agree that building up a ‘buffer’ of savings, in case of problems with cash flow or for unexpected events, is always a good idea.

Step 1: Calculate your net take home pay

• In case you are an employee with a salary, take into calculation your credited salary. If your employer deducts PF, health insurance fees etc add those back in.
• In case you are self-employed, this is your gross income minus your business expenses and the amount you set aside for taxes.
• In case your partner and you are budgeting together then can add your after-tax income together to make a budget for your household.

Step 2: Calculate headers

In this step, you have to divide your income between three spending categories: needs (50%), wants (30%), and savings (20%). Below mentioned are few examples:-

Example 1:-

Example 2:-

Note: - 20% is the absolute minimum that you should be putting into this category. It should be your goal to put more than 20% of your take-home pay into your savings each month. It is here where your money will work for you:-

• Putting money into a pension fund.
• Building up an emergency fund.
• Overpaying on debts.
• Investing in a fund or stocks and shares.

Step 3: Limitation and optimization

Task here will be to limit need under 50%, wants under 30% and maximize savings over 20%. Same can be achieved by:-

• Earn more money: - Sometimes cuts or changes can be made, but otherwise, perhaps it’s worth considering a side hustle or a change of job.
• Save as much as you can: - Relooking in wants and needs bucket for optimization and reduction.
• Look at your housing needs: - Often housing is one need that takes up a huge chunk of income and it’s not something that can be changed overnight. Even people on higher incomes can get caught in the property trap.

The last 20% goes on saving. This could be any sensible money goal and is not just limited to putting money in a savings account.

Step 4: Saving Strategy

The final step is to allocate 20% of your income which is savings towards debt payments and investments. As savings won’t make you rich you need to invest savings towards your financial goal.

• Create passive income options through investment in stocks, mutual funds.
• Create retirement funds.
• Be smart about your debt and clear as per interest rate.
• Track your investments.