Budgeting 101: The different ways to budget
In his book “The Total Money Makeover” American author and radio host Dave Ramsey wrote, “A budget is telling your money where to go instead of wondering where it went.”
Let’s be frank, very few people get a kick out of creating a budget. But a budget is the cornerstone of a healthy financial life.
A budget is telling your money where to go and what it should do. A budget puts you back in a position of power because you intentionally decide what you will spend your money on, and help you make some decisions on what you are prepared to live without to reach your personal goals.
Budgeting should be simple: Income less expenses
To have a realistic idea of your monthly budget, you need to analyse your spending over three months. Not only do you need to review three months of bank statements and credit card bills, but you also need to write down everything you spend on a daily basis. It’s often those small daily cash expenditures which really add up. You also need to take into account your less frequent expenses such as school fees, maintenance and home repairs.
It is also important to include other commitments like payments to support family. Many people assist family members financially, whether this is a parent, a brother or a niece. I specifically put this under fixed costs as it needs to be budgeted for rather than being an ad-hoc payment. In these uncertain times, it is important to have a clear idea of how much you can afford to assist family members, and to limit your assistance to what you have budgeted for.
Write down all your sources of income and then assess the damage. If your monthly expenses bear little relation to what you earn, don’t worry ‒ you’re not alone. Most households are in the same position. The difference is that you are starting to do something about it.
Understanding your budget better: The different ways to budget
Not one method of budgeting will work for everyone but here’s three methods to consider when you approach your budget, as well as your grocery budget - a major part of your monthly spending.
Method 1: The 50/30/20 budgeting rule
The 50/30/20 budgeting rule is a guideline to how you should split your income effectively and focuses on three main categories: Needs, Wants, and Savings.
Firstly, differentiate between which expenses are wants and which are needs, then allocate 50% of your after-tax income to your needs.
You then look at your wants and allocate 30% towards those.
Paying your debt, your savings, and your investments should account for the remaining 20% of your budget.
Step 1 – Your needs (50% of your budget)
- Housing (Bond/rent)
- Water & Lights and services
- Car repayments/Transport
- ‘Family tax’
- Medical aid etc.
Step 2 – Your wants (30% of your budget)
- Dining out
- Hobbies etc.
We often underestimate just how much of our money goes to wants. People convince themselves that they don’t spend so much on wants when in fact, it makes a big chunk of their expenditure.
It might not be large sums of money. The coffee in the morning, dining out with friends here and there, the gym membership you hardly use - it all adds up!
Step 3 – Your savings (20% of your budget)
Your savings allocation says a lot about debt, it shows that ideally, consumer debt should not even be part of the equation, thereby leaving you with more money towards your savings and investments.
Method 2: The Kakeibo method
Kakeibo – which means ‘Household Financial ledger’ is a Japanese budgeting system that helps you track your spending.
The Japanese have successfully used this system for over a century to manage their household budgets. The core of this system is to help you understand your relationship with money as you record EVERYTHING that is coming in and going out!
When applying the Kakeibo system, you go back to basics. This implies no apps or excel spreadsheets, just two notebooks: One where you record your income and expected expenses once a month, and the other notebook (preferably one that fits into your bag) where you write EVERY single expenditure you make throughout the month.
There is something profound and reflective about writing down your expenses by hand as it brings you closer to your spending habits. We often lie to ourselves about just how much we spend on certain things, and this system allows you to come face-to-face with yourself and your habits.
At the end of the month, you reconcile what is in the first notebook to the daily expenditure notebook. The Japanese believe this leads to more mindful spending in the longer term.
Method 3: The envelope system for miscellaneous expenses
The envelope system is a method of budgeting in which you put money meant for different categories in different envelopes.
The point of using envelopes is two-fold. Firstly, the envelope method makes money that more tangible. There is something powerful when you spend physical cash and not just swipe plastic i.e. your cheque or credit card.
Secondly, because the money is categorized and you know exactly how much you have earmarked for spending on say entertainment, once the envelope is empty, you know that you have no more money for that category.
Method 4: Setting a realistic grocery budget
Groceries take up such a huge chunk of our budget, yet many of us still gamble, guess, and hope our way through the aisles.
With COVID-19, some of us were forced to hit the reset button on all of our spending —whether due to change of income, or to prepare for an uncertain future. You should also be asking yourself what you have been spending on groceries, and should you keep spending the same, especially if your financial situation has changed?
To figure out where you’re going, you’ve got to know where you’ve been. Before you do anything else, look back at the last two to three months of your grocery spending and find a ballpark average of what you typically spend on groceries each month.
Let’s say you typically spend R400 a month on groceries, and you decide to run for groceries every 10 days or roughly 3 times per month. R400 divided by 3 is about R134, and that’s your new grocery budget for every time you hit the store.
Another tip is to always build your grocery list before you get to the store or rather order online. This forces you to buy what you need and not what you want.
A handy budget tool: My budget planner
For a budget to work, it has to become part of your lifestyle, not just something you do once in a while!
In my book, “You're Not Broke, You're Pre-Rich” I provide readers with a short breakdown of what a budget could look like and I hope you will find it handy. This tool will appeal to those who like using excel spreadsheets!
Be realistic, and remember to reward yourself
A reason why people fail in sticking to their budget is because they’re not realistic. They’re either too lax or too strict with themselves.
Keep a bit of money aside to treat yourself, especially when you’ve reached certain milestones like paying off your all your clothing accounts. Forming good habits can be draining and treating ourselves can play an important role to boost our self-command—and self-command helps us maintain our healthy habits.
Disclaimer: The advice contained on this blog is for general purposes only and does not take into account individual circumstances, objectives or financial needs. Accordingly, readers are advised to seek appropriate advice from licensed professionals prior to making any investment, or taking up a financial product or service.