- Friday, 16 April 2010
If I had a penny for every time I heard the words, “I make a lot of money, but I just don’t know where it all goes…” I would be a rich gal! To be fair, some clients who come to me are in crisis and are facing real changes in their standard of living, such as job losses or divorces. But for most, not knowing where their money is going is simply a result of spending unconsciously and without a goal in mind. Sound familiar?
Why Prepare a Budget at All?
Budgeting is necessary if you are finding it difficult to meet all of your financial commitments without going into debt. These commitments likely include: covering taxes, having a satisfying lifestyle, managing your debt, and saving for the future. Relying on debt is not an option because you will never achieve financial stability or be able to accumulate wealth with debt underfoot.
How to Prepare a Budget
Most people think that budgeting involves sifting through six months of credit card and bank statements and scrutinizing and categorizing every purchase. While that exercise will confirm where your money is being spent (and your incredible patience!), it will still not teach you about what you can realistically afford.
Instead, start with your earnings and work backwards to create a healthy spending mix. An example of a healthy spending mix could look something like this:
Up to 35% of gross income for taxes (depending on your jurisdiction)
30% - 35% of gross earnings for mortgage or rent and debt repayments
25% - 30% of gross earnings for lifestyle expenses
10% of gross earnings for savings
Naturally, different households will have different mixes. For instance, if you live in a jurisdiction that taxes you beyond the 35 percent mark, the other spending ranges must be adjusted accordingly. The moral of the story is that if you reduce the proportion that you are spending on any of these items, you can increase others. For instance, if you can take advantage of legitimate tax reduction strategies, you will have more left over for debt payments, lifestyle expenses, or savings.
Please note that if you are committing more than a third of your gross income to debt service, then it is important that you prioritize tackling your debt load even if this means saving less for the future. For those who are over-burdened with debt in this way, a frank discussion about whether your current standard of living is sustainable may also be in order.
Sample budget spreadsheets are easy to find online. The greatest feature of these online tools is their ability to remind you of expenses that you may have omitted if you were listing them yourself. I recommend that you complete one of these online spreadsheets carefully, but without sifting through statements, and then post it near your computer or wherever you keep your checkbook. As you pay your credit card bills and review your monthly bank statements, you can then glance at your budget to see how accurately you estimated your expenses and adjust where necessary. This method is a lot less time consuming than analyzing past statements and it will allow you to get a very accurate picture of your spending over a matter of a few short months.
Changing the Way You Allocate Lifestyle Expenses
Each dollar that you spend should result in a return on your investment. When it comes to budgeting, the return on your investment should be an increase in your overall happiness or your standard of living. Think of spending as the power to buy things that truly make you happy and improve your way of life rather than something that is done unconsciously or in reaction to stressful times. As long as you hold the wallet, you hold the power!
Many financial experts tout the “latte affect” – the total annual savings that can result from eliminating the daily purchase of a costly beverage. I recommend that you view your spending differently. If you buy your coffee out of habit – or heaven forbid, laziness – then it is not a worthwhile expenditure. But if going out for coffee affords you a much needed break during the day or a chance to catch up with a friend, then it provides you with a bigger return on investment. Again, relating the cost back to the return on your investment (happiness or an increased standard of living) can help you to determine whether to continue these spending patterns or change them.
There is no question that today’s busy lifestyles necessitate some exchange of cost for convenience; however, many of us have become slaves to this convenience. It is important that you take a step back and decide which conveniences are worth the cost and which are not. If you choose to own, maintain, and pay to park a car instead of using public transit because the convenience adds to your standard of living, then you must adjust your budget elsewhere to accommodate it. If you looked at all your expenditures as a way to improve your standard of living, you would spend differently.
Some conveniences are almost impossible to rationalize, such as bank fees charged when you use an ATM machine that is not affiliated with your bank or memberships and subscriptions that you do not use or enjoy. You would not throw out a dollar bill so why would you waste it?
Lastly, consider your strategic spending like a raise in your salary. A 10 percent reduction in your spending is tantamount to a 13.5 percent raise at work. Few of us can march into our boss’s office and demand a 13.5 percent raise, but we all have the power to spend less, spend more strategically, and enjoy our hard-earned money.
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