For any individual who’s on the financial planning path, budgeting forms the base of the strategy and is very important for overall financial strength. Many people often hesitate to chalk out a budget due to the fear that they will not be able to enjoy good things in life. However, budgeting is the starting point of any financial planning.
Just like a business can become financially weak if its income and expenses are not managed well, a family cannot remain financially strong if there’s a lack of budgeting. Budgeting suffers from the myth of being a complicated and tedious task. However, it is very simple if the entire process is broken down into a few small steps.
Let’s begin by understanding this concept in simple terms.
What is budgeting, and what is a budget?
Budgeting process starts with establishing a plan to spend available money. The plan for spending is called a budget. Setting up a spending plan lets you determine in advance whether there will be enough funds to achieve your goals or do the things that you must do or like to do.
Once a budget is chalked out, you can come up with a financial plan to prioritize your spending and allocate your money on things that are more important.
Why is budgeting important?
Since budgeting helps in establishing a spending plan for the available funds, it ensures that the spending can be planned and contained such that there is enough money for most of the things that you would need. Following a budget can also keep you away from debt or help you come out of debt if you currently owe any.
Identifying income and expense pattern
The objective of budgeting is to take note of issues in the income and expense pattern such that the result of income after expenses is never negative. With a few small changes to spending behaviour, you can improve your financial situation at any time.
Budgeting is key to personal-financial planning. By listing down the income and expenses of a household, budgeting can help in containing the expenses within the available income and estimate potential savings. The entire process of listing down and itemizing income and expenses provides clarity to one’s financial situation.
During working years, we tend to use our income or earnings for meeting current expenses first. A portion of this is saved and invested such that the corpus can generate regular income during retirement years. Different individuals may require different income to meet their current and future needs. Therefore, adequacy of income may not be the same for all and it may also differ across different stages of life. People who have higher earnings as compared to their expenses can save more than people who have income levels that just about meet their current expenses.
Young individuals who have just started earning may find their income levels too small to consider savings and investments. Oftentimes, they assume that they can save and invest towards financial goals or retirement only when their income levels increase in the future.
However, starting to save for the future only at a point when income levels are high can result in many life goals remaining under-funded. Therefore, it is important to start saving early and build a corpus out of savings such that there is limited or no risk of the accumulated funds being insufficient for the future. This can be achieved through budgeting since no matter the income, there is always a scope to save a portion towards future goals.
Financial discipline through budgeting
Budgeting is one of the ways of inculcating a financial discipline and saving for specific goals. A budget can help us manage our needs within the available income and continue to focus on savings for future goals. In the future, as we continue to raise our income levels, a budget helps in proportionately increasing the savings for clearly identified goals.
Mandatory expenses such as taxes, loan repayments, etc always have to be prioritised while spending from the available income. The essential living expenses such as housing, food, education, transportation, etc also have to be covered. These expenses cannot be avoided, however, you can cut back on them depending upon the available income and savings goals.
For instance, searching for a house in a less expensive locality and opting for public transport are some of the ways to reduce expenses towards essentials. Discretionary spending, such as entertainment and recreation, come under the least-priority expense category.
A budget helps in identifying avoidable expenditure that can easily be eliminated or limited to improvise saving for future goals. With budgeting, you can prioritize expenses and goals as per the expected income levels. It allows clarity on which financial goals can be practically achieved as per the available income and savings.
How to make budgeting a habit?
Budgeting is a continuous process and not a one time activity. A lot of times, we may start off budgeting with a strong motive, but within a few months, it can get sidetracked and lose its focus. It is therefore important to focus on budgeting benefits and specific objectives like becoming debt-free, saving for a dream vacation, retirement planning, buying a home or other future plans.
With time, budgeting could seem mundane and an avoidable task. By setting a few short-term goals and rewarding yourself when they are achieved, the motivation for budgeting can remain steady. Keeping realistic expectations about the outcome of the budget is another way of ensuring that budgeting becomes a habit. You can see progress through budgeting only over a period and through constant practice.
The 70-20-10 rule is used in financial planning, under which, every month, a person can spend 70% of the earnings, save 20%, and donate 10%. This can be used for monthly budgeting and taking better control of finances.
SIPs allow investors to invest small amounts of money over a longer period of time rather than making large lump sum mutual fund investments.These offer the benefit of rupee-cost averaging and help in better financial planning, especially for meeting specific objectives.
One of the best financial advice is to begin saving and investing while you are still young. Saving at least 15% of the earnings can help in the long run.
Investors who are just starting off in their financial planning journey can consider investing in passive funds, such as ETFs or index funds. These can help in fetching returns that are mirrored to an index and allow an investor to meet his/her financial goals in the long run.
Risk aversion plays an important role in determining return on an investment that an investor can fetch. Investors should consider personal risk aversion before investing in certain avenues, like equity mutual funds, to ensure maximum gains from the investment.