Source/Contribution by : NJ Publications
Budgeting is simply creating a plan to spend your money. This plan is the “budget” which allows you to determine in advance how much will you spend, where will you spend, and if you will be left with enough money by the end of it all. In simple words, budgeting is simply balancing your expenses with your income or cash outflows with your cash inflows.
Needless to say, budgeting is the single biggest tool you have to take control of your money, achieve your financial goals, and set yourself up for long-term success. You must already have been advised many a time to follow a proper, detailed budget. But do you? It is very rare to find any person who religiously follows budgeting. Perhaps only one in hundred may do some sort of budgeting exercise on paper every month. Is there a better, much easier way? In this article, we will attempt to take a short-cut to the entire budgeting exercise to encourage you to start on the path…
The guiding rules:
The idea is to create simple money boxes to bifurcate your spendings. To begin with, keep the boxes simple and easy to understand and bifurcate. As you progress and enjoy the journey, you may go into details and increase the type or number of boxes.
You may ask, how to manage? Well, to begin with, you may simply allocate money to the boxes in your mind. You may also keep a rough track of the boxes on paper - just to ensure that you are not way off the mark. In the starting month, you may skip minor expenses and record only major ones. However, the proper way to do will be to put your expenses on paper, at least once a week under different boxes. In the first month, you may also skip pre-deciding the allocation into different boxes and simply observe your expenses and then decide allocation from the new month onwards.
Remember, it is not important how elaborate plans you have made. What is more important is what you can track religiously. It is like running a marathon, your timing, speed is not important, what is important is that you cross the finish line.
Let us start by making four simple boxes to account for all your cash outflows.
Box One: What you Owe:
Perhaps the challenge for most households would be payments towards your monthly commitments. This is the box you cannot avoid and has to be accounted for anyhow. This would include your home rent, home /car /personal care EMIs, society maintenance, etc. Consider yourself lucky if such expenses are below 20% of your income. However, you are in the red zone if it is over 50%! If it is so, you will need to immediately start thinking of reducing your loan burden and/or look at increasing your income sources over time.
Box One: Living Expenses:
Next comes the living expenses which again one may not compromise. School fees, groceries, utility bills, medical care, maid salary, tuition fees, mobile/cable/internet recharges, etc are the expenses falling under this box. These expenses are relatively stagnant /fixed for the month and do not change often or by a big margin. This box should ideally not take more than 20-30% of your cash inflows. Again, if it is more, it would simply mean you are living beyond your means.
Box Three: Savings:
Next in priority would be all your cash outflows towards the non-expenses, ie., insurance and investment payments. Club all your yearly /monthly expenses together to arrive at a fixed allocation every month and save accordingly. This would include your life /health /motor insurance premiums, mutual fund SIPs, bank /post office recurring, PPF savings, etc.
Among investments and insurance, priority should go to insurance as protection is for today’s financial security and survival while wealth creation is for tomorrow’s financial well-being. Ideally, everything left after the first two boxes should fall into this last box. A minimum of 20% allocation should be made to this box and if it is over 50%, consider yourself fit for the next level of planning.
Box Four: Optional Expenses /Discretionary:
Now we have reached the most interesting question. How much is left in your pocket by the month-end?
Ideally, if you have allocated all your money smartly, less than 10% would have been left. If it is more, there is a clear indication that more allocation needs to go to the Savings box. Ideally, 5-10% would be sufficient for you to spend on entertainment and other things. Simply put, if you are earning a lakh rupees, not more than Rs.5,000 should be spent on food or movies or shopping, etc every month. You can stretch it to max 10,000 but only if your savings box is over 50%.
If you have exhausted all your cash flow and are in fact in the negative, it is a big red zone! You need to immediately sit with your financial guide /advisor and find out how you can plan your finances better.
If you feel you are putting a good amount of money into this box, it should be interesting to peep inside and try to further define another set of boxes within this savings box. Why? Because the savings box is a very important box which is directly associated with your continued and future financial well-being. This box deserves a further breakup to ensure that you have covered all aspects of your financial well-being adequately.
Box One: Insurance /Protection
The most import box comes first. Ideally, if you are saving over 20-30% of your income and out of that insurance premiums are over 30% (of savings) then perhaps your choice of insurance policies needs to be seen closely.
Traditional life insurance plans (like endowment /money-back /return of premium + bonus plans, etc) offer little in terms of protection cover /sum assured and but comes at a very heavy cost of low returns on the heavy premiums you pay. A good insurance portfolio would comprise of Pure Term plan + Health Cover + Personal Accident Cover + Critical Illness cover. Sit with your financial advisor today sort out this box
Box Two: Long-term wealth creation
This is the box, where your ‘real savings’ for a better, secure future where you desire to spend towards your life goals like marriage for children, home purchase, second home and most importantly - towards your peaceful and financially secure retirement. Needless to say, the more you save, the better it is. Ideally, you should at least aim to save 20% of your income towards this box.
The best way to plan for this box is to go into reverse! Start by first identifying your life /financial goals and then by estimating how much of mutual fund SIP would you need to fulfil those goals? That should be your allocation to the box - it should be pre-decided and not left as the result or output after everything else. Ideally, it should be over 60% of your savings box.
Box Three: Short-Term money deployment
Finally, we come to the box wherein you would like to keep some money handy. These would count your cash holdings at holding, bank balance, savings towards emergency fund (if planned), etc. This should also cover money you wish to keep aside for upcoming big expenses like purchase of electronics /holidays /festivals /family events and so on.
Instead of dipping into your long-term savings, which is a strict ‘no’, to meet such expenses, we highly recommended that you plan in advance and save in parts in the preceding months before the expense happens. This is help you do two things - (a) avoid cutting your long-term money tree when they are young and (b) avoid taking loans /credit. Ideally, 10-20% of your savings box may be allocated to this box.
Those who fail to plan, plan to fail. The money box approach is a good way to begin planning your finances in an interesting and easy fashion. Again, what is important is that you actually begin, do this consistently for a few months, develop the ‘budgeting’ habit and then move on to detailed plans, if required. We are confident that such an exercise will surely help you understand your own status and also help you set targets to achieve in the coming months.