How to become better at budgeting and saving?
Struggling to budget well and save money boils down to a lack of understanding of how to make a budget work.
If you are trying to increase your savings from your income and build financial resilience, understanding how to budget in a methodical way can make a significant difference to you.
This is the first of a 3-part blog that looks at how to understand budgeting better, challenges in budgeting, and how to overcome those challenges. Let’s take a step back and find out why you need a budget in the first place before understanding how it works.
Why do we need a budget in the first place?
We want certainty in our financial life. We don’t want rude surprises and we want to make sure we have enough resources to meet our immediate and future needs.
Budgeting is the essential first step to understand what you need for your immediate expenses and what you need for your future expenses.
We don’t know our future needs precisely
Monitoring and tracking our everyday expenses are important steps for knowing what we need for our immediate expenses.
As far as needs for our future is concerned, we don’t know our future needs precisely, except for specific targets such as a deposit for a home purchase or short-term goals such as saving for annual holiday spending, etc.
Apart from specific goals, we need to have savings to help us through unexpected events such as loss of income. Calculating an exact amount for what we want to save each month for the future is essentially a finger-in-the-air as we don’t know how much money we will need in the future unless one is planning for retirement.
If money were not a scarce resource, we wouldn’t need to budget in the first place
Erring on the side of caution is perhaps a more practical policy, and one should try to save as much as possible from their income rather than just sticking to a certain amount to save.
What are the ways of budgeting today?
Budgeting has been an essential survival strategy for humans since time immemorial. We have come a long way from budgeting and saving food using salt and fermentation to budgeting money for meeting immediate and future needs.
Today people use a range of methods to budget and save -
1. Traditional methods such as record-keeping in a notebook and segregating money in jars/pots etc.,
2. Spreadsheets and websites where one can enter their own data and keep track of their money,
3. Budgeting apps that provide a more automated and convenient solution to budget money for immediate expenses as well as set aside for future needs.
Each of the methods to budget listed above has its own pros and cons. Analysis of the different methods of budgeting is a topic for a separate blog. In this blog, let’s focus on the mechanism of budgeting in general.
How does the budgeting and saving process actually work?
Budgeting is, essentially, setting up a rule or a framework for how one is going to manage their scarce resource i.e., money from their income. If money were not a scarce resource, we wouldn’t need to budget in the first place.
Saving money and budgeting go hand in hand. From one’s income, the money that they don’t spend (including on investments) is what they save. Let’s have a detailed look at the process of budgeting.
Reviewing and adapting is by far the most critical step that determines if you get any benefit out of budgeting
There are 4 components of budgeting —
- The goal setting i.e. how you want to manage your money,
- Actual spending i.e. how you actually manage your money,
- Record-keeping i.e. how you track your actual spending, and
- Reviewing and adapting i.e. synchronising how you want to manage your money and how you actually manage it.
Let’s look at them in detail.
1. Goal setting
This involves -
i. Understanding the amount, timing, and frequency of your income,
ii. Understanding your financial obligations (e.g. debt repayment, if any) and expenses across various spending categories on a periodic basis (e.g. monthly basis),
iii. Setting spending limits for expense categories where you want to cut down the spending (e.g. £50 per month on drinking),
iv. Allocating money from your income to the various expense categories and to meet financial obligations,
v. Allocating money from your income for investing (if any),
vi. Allocating money for generic or specific savings targets from your income (e.g. saving £100 per month for holiday, £200 per month to pay off debt, etc.).
This is the plan for how you may want to use the money from your income.
2) Actual spending
This relates to the real-world spending transactions you make from your bank account, to meet your immediate needs and financial obligations. You may use credit to meet a part or all of your expenses or financial obligations, depending on your specific circumstances.
The actual spending may or may not go as per your plan discussed in ‘Goal setting’ in the above section.
3) Record-keeping
This involves making a note of all the transactions from your bank account. By default, your bank maintains a record of a basic set of information for all your transactions.
The amount of information on your transactions that a bank usually records and provides you may not be sufficient for you to make insightful deductions of your financial behaviour.
So, you may have to augment the information provided by the bank with something that is more meaningful to you. For example, consider the transaction from your bank statement: £5.25 at ‘SS F&Chps’ on 15th April 21 for your takeaway at ‘Sea Side Fish & Chips’. On its own, this information may be less insightful than augmenting the information that it is a ‘takeaway meal’. That way you can keep a record of all spending on takeaway meals.
Budgeting today is more complex than it has ever been
Timeliness of record-keeping of transactions is also important. For example, if you want to keep your takeaway meals spending within a limit, then you need a timely recording of your last expenditure on a takeaway meal so that you remain informed through your budgeting exercise on what you have spent on takeaway meals so far.
4) Reviewing and adapting
Reviewing and adapting is by far the most critical step that determines if you get any benefit out of budgeting or if budgeting is a futile exercise for you. You will derive maximum value out of budgeting if you are able to achieve the goals you have set in ‘Goal setting’.
3 Reasons for missing your budgeting and savings goals could be that -
i. Your goals are unrealistic,
ii. Your goals are realistic, but you may need to be more mindful of how you spend to meet those goals, or
iii. Unexpected and unavoidable events occur.
The first two of the above reasons can be corrected. Correcting this will require you to -
i. Review your budgeting and savings goals,
ii. Review your actual spending,
iii. Determining if changes need to be made to either your goals, your actual spending, or both.
I will write about why it is important to continuously review and adapt to your budget in another post.
How easy is it to make budgeting work to save more?
Budgeting today is more complex than it has ever been. It has become more difficult to set a realistic budget and stick to it. The primary drivers of this increased complexity are -
1. Increasingly easy ways to spend,
2. Easy availability of credit,
3. A move towards a cashless economy.
In the second part of this 3-part blog, I will write about the challenges in saving more by budgeting. That will help in increasing your understanding further about the budgeting process and how it can help you save more.
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