Topic 2: Write Down Your Budget
You earn well but are unable to save. You have no idea where your salary goes. You sometimes borrow to pay your bills. If any of these statements applies to you, it's time to write down a household budget.
Many people are put off by the word budget because they associate it with restrictions on spending and frugal lifestyles. That's a misconception. Budgeting does not make you spend less, but allows you to spend smart. "A good budget lets you focus your money on the things that are most important to you," says personal finance expert Carl Richards. By preventing you from overspending on less important items, a budget channelizes resources to areas that should be given priority.
Write It Down
The first step in budgeting is to write down the various sources of income. This includes salary, rent, interest on deposits, dividends, etc. Then make a list of expenses incurred in a month and allocate money to each of these heads. Include everything, from the grocery bill to what you pay the maid, from fuel expenses to the EMI of the car. For some expenses, such as school fee or insurance premium which are paid every quarter or once a year, you may have to calculate the monthly figure. There's a widely used 50:30:20 rule of budgeting. This back-of-the-envelope principle says 50% of your income should be used for essential expenses (food, shelter, clothing), 30% should be used for discretionary spending and 20% should be put into savings. But this is not an iron-clad allocation and could vary across individuals and financial circumstances. Those with big-ticket home loans may find that their housing cost is almost 50-60% of their income. We looked at the spending pattern of the average middle-class urban Indian household and tweaked the formula to make it 60:20:20
Setting Limits For Categories
Apart from the broad limits for each type of expense, there are some sub-limits for specific categories. Your monthly outgo for loan repayments should not exceed 50% of the monthly income. This is also why lenders scrutinize your bank account statement to see how many EMIs you are servicing before they extend a loan to you. It's okay if your EMIs are up to 50% of income if they include one for a home loan. But car EMIs should not exceed 15% while personal loan EMIs should not account for more than 10% of the net monthly income. If your EMIs gobble up too much of your income, other critical financial goals, like saving for retirement or your kids' education, might get impacted. Retirement planning is often the first to be sacrificed in such situations.
Keep It Flexible
The best budgets are those that allow the household some flexibility. If you have some money left over in one category, it should be used for expenses where you are facing a shortfall. The only exception to this should be the money earmarked for investing. As a rule, this money should not be used for any other category except in case of a dire emergency. This will ensure that overspending does not impinge your financial goals.
Your Financial Forecasting Tool
Once you start following a household budget, in about 2-3 months, you will notice a pattern in your spending which will tell you where you need to cut down or how you can get more out of your money. Your savings pattern will allow you to draw up plans for short-term and long-term financial goals, such as a vacation, a new car or your child's education.
Your budget will tell you exactly how much you would have saved for these goals in the given time. A household budget is a guide that helps you live within your means. However, it should not be based on flawed assumptions and incorrect information. A budget that is too ambitious or impractical is likely to fail.
Source: Times Of India
Many people are put off by the word budget because they associate it with restrictions on spending and frugal lifestyles. That's a misconception. Budgeting does not make you spend less, but allows you to spend smart. "A good budget lets you focus your money on the things that are most important to you," says personal finance expert Carl Richards. By preventing you from overspending on less important items, a budget channelizes resources to areas that should be given priority.
Write It Down
The first step in budgeting is to write down the various sources of income. This includes salary, rent, interest on deposits, dividends, etc. Then make a list of expenses incurred in a month and allocate money to each of these heads. Include everything, from the grocery bill to what you pay the maid, from fuel expenses to the EMI of the car. For some expenses, such as school fee or insurance premium which are paid every quarter or once a year, you may have to calculate the monthly figure. There's a widely used 50:30:20 rule of budgeting. This back-of-the-envelope principle says 50% of your income should be used for essential expenses (food, shelter, clothing), 30% should be used for discretionary spending and 20% should be put into savings. But this is not an iron-clad allocation and could vary across individuals and financial circumstances. Those with big-ticket home loans may find that their housing cost is almost 50-60% of their income. We looked at the spending pattern of the average middle-class urban Indian household and tweaked the formula to make it 60:20:20
Setting Limits For Categories
Apart from the broad limits for each type of expense, there are some sub-limits for specific categories. Your monthly outgo for loan repayments should not exceed 50% of the monthly income. This is also why lenders scrutinize your bank account statement to see how many EMIs you are servicing before they extend a loan to you. It's okay if your EMIs are up to 50% of income if they include one for a home loan. But car EMIs should not exceed 15% while personal loan EMIs should not account for more than 10% of the net monthly income. If your EMIs gobble up too much of your income, other critical financial goals, like saving for retirement or your kids' education, might get impacted. Retirement planning is often the first to be sacrificed in such situations.
Keep It Flexible
The best budgets are those that allow the household some flexibility. If you have some money left over in one category, it should be used for expenses where you are facing a shortfall. The only exception to this should be the money earmarked for investing. As a rule, this money should not be used for any other category except in case of a dire emergency. This will ensure that overspending does not impinge your financial goals.
Your Financial Forecasting Tool
Once you start following a household budget, in about 2-3 months, you will notice a pattern in your spending which will tell you where you need to cut down or how you can get more out of your money. Your savings pattern will allow you to draw up plans for short-term and long-term financial goals, such as a vacation, a new car or your child's education.
Your budget will tell you exactly how much you would have saved for these goals in the given time. A household budget is a guide that helps you live within your means. However, it should not be based on flawed assumptions and incorrect information. A budget that is too ambitious or impractical is likely to fail.
Source: Times Of India