Budgeting

For a variety of reasons — personal, business, linux australia, linux.conf.au — I’ve been poking at budgeting lately. I thought it might be worth a post on some of the ideas that I’ve found useful; if they turn out to be too obvious, well, bad luck. :)

The way to look at a budget, it seems to me, is as a way of balancing out priorities. For a personal budget, you want a roof over your head, you want to eat, have transport, spoil yourself, not work too hard, have a holiday now and then, and probably try to save up for retirement. A budget lets you translate those things into numbers, so you align your expectations: you’ll probably find, for example, that you can’t spend $500 a week partying, have an overseas holiday every six months, and be a multi-millionaire by the time you’re forty while only working twenty hours a week at minimum wage. But knowing what things you are trying to balance out gives you options: maybe you don’t have to be a multi-millionaire, maybe you’re happy to trade eating out and watching movies in order to have the holiday, and maybe if you’re cutting down your entertainment through the week anyway you can do more overtime and get paid a bit more.

If you don’t balance your budget that way, but instead leave some of the parts as assumptions — like “my salary is such-n-such, where does it go?” — you risk not being able to handle surprises. What if there’s a global financial crisis and you take a paycut to avoid losing your job? The more your budget can tell you “if such-n-such happens, then that means I can’t afford this anymore” and “if I want to afford that, I need to make sure such-n-such does happen”, the better off you are. And if you can take fairly conservative, pessimistic estimates — I won’t get a payrise or a bonus, I’ll probably lose $10,000 over the year from accidents or something, I’ll probably have to spend more on groceries than I expect, etc — and still keep the results roughly matching your goals (not working too hard, an annual holiday, not sleeping on the streets/starving to death, etc), then you’re likely to end up in a better situation than you planned. And even if everything does go wrong, you’ve already factored that in. And if you can’t come up with something like that, you at least know what sort of risk you’re running, and can start thinking about how you can minimise it in future.

For me, the two biggest tricks for getting my day-to-day expenses better managed were giving myself a weekly allowance for things like eating out, paying for petrol, buying alcohol, and such; and buying my groceries online once a fortnight with a fairly strict budget. The theory there is that they stop being variable expenses and become predictable, more than whether or not I’m spending less overall. If I find I’ve got $20 in my wallet to tide me over ’til next week, I’m not eating out; if I find I’ve collected a few hundred dollars because I haven’t been going out much over the past few weeks and a PS3 game catches my eye, I don’t have to feel guilty about splurging: it’s already been factored into my budget. And buying groceries online, while a little more expensive, means I can aim at a particular dollar figure, without having to keep track of amounts in my head, or end up in the last aisle with more than I want to spend, and having to wander around putting stuff back on the shelves. Having it delivered in a truck is also easier than carrying it in a backpack on a motorbike, too. Removing the hassle from regular expenses, and reducing the amount of guilt and worry that comes up about irregular expenses is a worthwhile win of its own.

Adding all your weekly, fortnightly, monthly and annual expenses like that up gives you a rough idea what your minimum disposable income is: how much you’re earning that just goes into keeping you pretty much exactly where you are. But you probably don’t want to just stay where you are: you probably want to move ahead at least a little. Maybe that means paying off debt, maybe it means owning a house so you don’t need someone’s permission to put in new powerpoints, maybe it means spending more on yourself each week, maybe it means having a million dollars just so you can brag about it. Which means earning more than you need to, so you can save it up and then either brag about it, or spend it all again while retired. I made a spreadsheet a while ago to see what that actually looked like — you set your current income and expenses, how much you think those will increase each year, and it tells you how much you’ll have in assets over the next twenty years, and how close you’ll be to being able to just live off the interest those assets earn. It doesn’t take inflation into account, does take (current) Australian tax brackets into account, but doesn’t deal with any of the differently taxed ways of building assets, like trading shares or property (capital gains), superannuation (tax breaks, co-contributions), first home savers, etc. But there are benefits in keeping things simple too.

One assumption that’s worth pointing out is that it assumes your assets actually earn an income for you; which isn’t something you get from owning your own home unless you either sell it and move somewhere cheaper, or rent out part of it. A few years ago when I last looked, owning a home in the city was a lot more expensive in interest costs than renting — which is to say purchasers were paying a premium for the expected capital gains when they eventually sold. Getting into that sort of situation, as far as I can see, is probably a bad idea if you’re comfortable with the vagaries of renting: it’s effectively increasing your fortnightly expenses, and locking up a lot of your assets in something you can’t easily convert into anything else should you need it. Maybe that’s desirable if you’ve already got a lot of investments and want to have something stable, or you’re expecting rents to rise substantially or similar, of course. And that’s not always the circumstances you’ll find yourself in; depending on where you live, renting can be more than the interest costs of a loan, in which case buying can be a good idea from your budget’s perspective. You’re reducing your regular costs, and are likely to be putting a decent amount of your savings somewhere you’re not going to easily fritter them away. And if you’re lucky when you do eventually sell, you’ll not only benefit from the savings in rent, but you’ll also sell for more than you paid, and be even better off. But unless you’re buying out in the country, you’re probably not that lucky these days.

Anyway, at over 1000 words, I guess that’s probably long enough. I wonder if it’s actually interesting to folks out there…

2 Comments

  1. Dano says:

    Hi I personally found this very interesting.. I’m a big fan of budgeting and have thought about it quite a bit. I’ve budgeted a number of different ways and at the moment I’m using the zero balance monthly budget where I work out my net income for the month ahead, then allocate it completely until I have $0 remaining. It goes to debt, recurring/fixed expenses and everything else until I have $0 remaining for the month. Then on the 1st of the next month, I do it all again. I know exactly what’s coming in for the month, how much I have committed to debt, fixed expenses (home loan/car loan etc), savings and what’s left over. If I know my car registration is due that month, then I have less ‘play money’ for the month and reallocate where necessary. It’s kind of tricky to explain, but I think of it like a holiday or the car registration. My car registration is due yearly (or 6 months depending how you pay) and at $550 / year, my budgeting software will tell me to save $10/week for Registration. Likewise, A holiday is a point-in-time occurrence and budgeting software will spread the cost of it out over a year ($50/week for a say 3 week holiday after 2 years – $5,000). In reality I find it much more difficult to save like this. Instead, I’d say – OK it’s getting time for a break, and I would allocate everything I could in my monthly zero budget toward the holiday and (hopefully) have the money together in a few months. For the car registration, the month I know the bill is due I pull money from whatever categories I need to (fast food, eating out, movies, drinks… whatever) until I have the $550 allocated for that month to that bill. I know what I have for ‘fun’ (mightn’t be much that month!) but I know exactly where my money has gone and how much ‘play money’ I have each and every month. Finally it’s imperative you have an emergency fund… $2,000 is a good starting amount – for things like when your clutch goes in the car or the fridge breaks down, for whatever ‘emergencies’ might/will happen. This way your $0 balance monthly budget doesn’t get affected until the next month, where you allocate enough (over a month or longer if you wish/if necessary, to build back up the $2K emergency fund).

    There’s many ideas out there!

  2. Byron says:

    For people concerned with budgets and cash flow, which should probably be most people at present, this sort of post is always good!

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