Is budgeting a necessary habit?
“You don’t have to see the whole staircase, just take the first step.”
I wrote in my blog post Banking on you Habits about why healthy finances are important, but really I don’t think it needs much explanations. I think there are few people who never have that anxiety in the pit of their stomach when they think about their credit cards, emergency fund (or lack there of) or their pension and if they will ever be able to retire.
I’m here to tell you that you can find a calm around your personal finances, no matter your income level, and that’s the calm that comes from knowing that you are doing the right thing, that you are on the right track. And the first step: Knowing where you money goes!
Learn: Do you know where your money go? Yes? Good! If not, you may want to consider taking a look. I thought I had a pretty good idea where my money went but some time ago I decided that it was time to tackle my finances for real and as a first step I decided to actually calculate for myself what I was spending my money on. I went through the last year’s credit card, bank and PayPal statements and categorised what I had spent my money on. And I had a chock. Last year I spent over four thousand pounds on clothes, shoes and accessories! OVER FOUR THOUSAND! Mind, I did get a promotion last year and had given myself permission to spend a bit extra to treat myself but OVER FOUR THOUSAND POUNDS! I didn’t want to continue spending that much moving forward. The other thing I realised was that my 28 pound every 3 week nail saloon habit was costing me 485 pounds per year and my highlight and haircuts another 600 pounds. These are all things to consider.
Now, why wouldn’t I spend this money? I have a good career, a good income and I should treat myself for my success right? Yes and no. After finally getting a grip on my complete financial situation I realised that I had other priorities and that there were other things I prefer to do with my money but more about that in later post.
To learn for your self what you are spending your money on you will need to take the time to do this for yourself. Before you do, you can’t make any decision around if you are happy with your spending habits. Are they in line with your values? Is this what you want to spend your money on? It will take a couple of hours but once it’s done, it’s done, and you will be happier (though slightly petrified if your findings are anything like mine!).
Done? Great. Now that you know what you are spending your money on, let’s make a process that makes sure that for every month you are better off, rather than worse, and that makes sure that the money you are spending is in line with your values, what you want to do with your life.
Systemise: Pete Matthew, Chartered Financial Planner, has a great podcast and YouTube series about budgeting with meaningfulmoney where you can learn more, but these are the steps you need to take:
Set up a simple budget with your main spending. For most of us that will be rent or mortgage, other loans such as credit cards, student loans or car loans, household bills, childcare if you have kids, food, clothes and entertainment.
Add a row for savings.
Allocate how much (based on your usual spending) you want to spend per month.
Decide how much you want to save. How much you should be saving depends both on your preferences but also on what kind of loans you have. If you have expensive loans such as car loans or credit card debts, pay those of first and more on that in an upcoming post.
Remember that you have some expenses that don’t happen every month, for me these are things like getting my hair done (200 pounds every 4 months), MOT and service on my car (240 pounds per year) and the quarterly repayment for my Swedish student loan (300 pound every 3 months). If we just let these costs hit us without preparation, it can easily take us off course so we prepare for it by setting off some money into an easily accessible savings account on a monthly basis. You can easily open this online with most banks and setting up a monthly automatic transfer the day after you get paid will make sure that there is always money for those items that you know are coming even though they may not happen every month. Based on the above, I spend yearly 600 pounds on my hair, 240 pounds on car MOT and service and 1200 pounds on my student loan. Spreading this out over a year it’s 600+240+1200 pounds = 2040 pounds per year equaling 170 pounds per year into this “equalizer” account. I use this account for many things in addition to the ones listed here, like holiday savings and Christmas shopping.
Have a good think of what you want to spend your money on and remember that with most banks you can open several simple savings accounts for free, and you can rename the actual accounts so you have separate “equalizer” accounts for things like holidays, making it very clear what the money is for. It can also be quite satisfying seeing your “Holiday” account grow every month!
Pay yourself first. Now, make sure you set up direct transfers for any expensive loans you are paying off and your long term savings so they go out of your account as soon as possible after you get paid. If you wait until the end of the month , there will likely be little left if anything - it’s human nature. Well, if you are one of the few people who usually has a ton of money left at the end of the month then feel free to save it but for the rest of us, setting this up automatic makes it happen easily and without thinking, and we make sure that we pay ourselves first, before we start giving money to other people!
Now, let’s do the same with your direct debits and other payments. Let’s make sure that everything that can be automated is, and that the money is taken out of your account as soon as you are paid, making it really easy to see how much is left to spend on the “fun” stuff. If you have payments going out at different days of the month, and especially if you have big bills that are being paid late in the month (we used to have a 50 pound internet bill going out on the last day before getting paid, and it surprised and disappointed me every month!) you can almost always call and write to ask to have it changed to another day of the month. It’s a one-time effort that will make your life a lot easier while more transparent at the same time! Win, win!
Review: Once you have done the initial work of budgeting, making sure you pay yourself first and set up your direct debits and transfers to your “equalizer” accounts it’s really up to you how closely you want to track your finances. If you have used the system I described above, the only money left in your current account is the money that you are allowed to spend on a monthly basis and as long as you are generally keeping within that amount that is enough! However, if you are one of the more detailed oriented people out there you may want o actually start track what you are spending your money on, having a clear picture on exactly where your money is going. It is completely up to you and as the purpose of setting up these systems is that they then require minimal effort to maintain, only do this if you actually find value in it.
There are two things however that I want you to look out for and that should trigger a review of your personal finances:
First, you are spending more than your allocated “fun” money most months. If this is happening you have either set your budget to stringent or you need to change your habits to spend more money. This is a good time to take a new look at your spending and see in what areas you really are overspending. Remember, this is not about being boring and sitting at home all the time, but it is about making sure that your spending is in line with your values. Do you want to spend 500 pounds a year on lattes? If not, maybe it’s time to get a to-go cup and drink your own coffee on the go? Or even cut down? Or maybe just get a white coffee instead of the latte with extra caramel? It’s up to you, but this way, you make active choices rather than letting your personal finances happen to you.
Second, your circumstances change. If you get a salary increase, lose your job, move house or your partner moves in with you, you need to check your budget to see how this will affect you. If you will have more money left over, like after a pay rise, that’s great! Now, don’t just use it to buy a car or increase your “fun” money but really think through what you want to do with this extra money. There is a ton of information out there around how to get a pay rise but there is very little information, guidance or data to help us understand what to do when we actually get one. US Senator Elizabeth Warren, former law school professor focusing on bankruptcy law, famously advocates that you save 20% of your income after tax, so if you get a pay rise you would increase your savings to get you back to 20%. My recommendation would be to save between 50% and 90% of your pay rise depending on your goals and circumstances in order to slowly, and without you noticing too much, increases your savings rate. It’s important to feel that you gained something from your pay rise, and to keep up with inflation for your “fun” money (more on inflation coming in another post), but as we will see when we start talking about buying a house, pensions and investments, you will really benefit from not letting your ongoing spending run away with you - also known as lifestyle creep. And trust me, I know. Just look at my example where I got a pay rise last year. I did dedicate 50% of that pay rise to saving and investing but by giving myself a general permission to do some shopping, I very quickly was looking at spending patterns that, in the long run, would have done significant harm to my personal finances.
Now, were you should be on the 50-90% scale is up to you, but I would recommend that if you are really struggling and finding it difficult to buy essentials, only save 50% of the pay rise. If, on the other hand, you already have a bit of money to spend, then save 90%. You will still get a little boost in your fun account but most of the money will go to more worth wile goals.
Why should I save this much you wonder? We will talk a lot about this further posts on on saving, investing and pensions, but in essence it’s about having F-U money (more on this in the post banking on your habits). To make sure that as you go through life with the option to move if your landlord is being rubbish or to be able to quit your job if it’s really getting to you. It’s about setting you up for a life where you have choices. Choices about what you do, how you live, and what rubbish you put up with.
Unfortunately it’s not always a change in circumstances leads us to have more money to spend, just as often something happens that impacts our finances in a negative way with the probably the most impactful being if we lose our job or need to take a pay cut for some other reason or have a significant personal change in circumstances like getting a divorce or even have a kid! When this happens there are three things to focus on as you review your budget.
1. Fixed outgoings. Look at your budget or your list of direct debits in your bank. Can you change any of these? Depending on the scale of the cut-back this can be looking at any subscriptions you hold (do you really need that magazine or those extra tv channels?) or it may be looking at something bit more substantial like where you are living or how you get around. Is this the time to sell your car and get your daily movement from cycling around? Remember that a change of circumstances will require you to change your habits and routines so this is an excellent opportunity to look at the life you want to live, and see if you can adjust your spending to help you get there.
2. Look at your discretional spending. Remember that our regular spending is all about habits. Where do you get your food? Do you cook or do you take regular take-ways and home delivery? What do you and your friends do when you see each-other? Can you start taking a walk together instead of hitting the bar or the coffee shop? Personally I love taking a walk with a good friend, as it usually leads to really good conversation. We still may get a glass of wine or a tea later but either we get that in each-others home, or even if we do go out, the bill is a lot less than if we spent the whole time there! We also got some movement and possibly some memories in to help nourish the relationship as well. So take a look at the habits influencing your spending. This is not about austerity and feeling sorry for yourself for not getting a take-out, it’s an opportunity to make your life work together to a better you, to maximize what you’ve got and make your habits work for you instead of against you.
3. Look at your level of saving. As you will see throughout this blog I’m a big proponent for saving and investment so this should really be your last resort, but if you just lost your job and have done all the steps above and you really need the money to survive, then you can take a look at your savings rate. Be clear though that this is a short term measure until you get another job or otherwise get back on your feet, not an opportunity to permanently loos all that saving momentum you have built up!
I know there is a lot of information in this post and I won’t deny that there is some up-front work with understanding your finances, setting up a budget/plan and making sure you pay yourself first, but once that is done it really takes very little time keeping an eye on your bank statement every month, and if you keep healthy personal finances as one of your overall goals, you can also work this in when you review habits and routines in other parts of your life, making sure that your health routines don’t mean you have to spend more money than you have on a fancy golf membership or health club, but that you keep all your overarching goals in mind. – Just to make clear, I don’t mind people who play golf, I just want to make sure you keep your overall goals in mind as you actively choose how you live your life!