Financial planning 101 - Step 2 - Budgeting
TLDR: Step 1 - Expense tracking
Step 2 - budgeting
The continuing series around financial planning 101. After the step 1 of expense tracking. We progress to step 2 in this post which is budgeting.
Budgeting is a crucial step towards in determining what is important to you. It is also tightly related to goal setting and defining investment horizons. But let us not go there yet.
There are several ways to budget and during my research for this blog, I cam across way too many types of budgets. But I would like to stick with 3 budgets to keep things simple
Envelope budgeting
Zero based budgeting
50:30:20 budgeting
Let us start with the first one
Envelope budgeting
As the name suggests it is an old fashioned budgeting method involving physical envelopes with the different spend categories.
Rent / Mortgage
Groceries
Entertainment
Utilities
Transport
Taxes - income / property
tuition
Shopping
Insurance
With all the different applicable categories created in envelopes, you put the amounts that you have budgeted into these envelopes and you only spend from those preset limits.
You can also do this virtually by using an app or spreadsheet to make virtual envelopes. But the principle remains the same.
Zero based Budgeting
The concept of zero based budgeting is the balance income vs. expenses and savings such that you get to a zero at the end of the month. So every single dollar / rupee needs to be accounted for as per the budget.
Here is a good starting point for more details - DaveRamsay
50:30:20
This one is probably the simplest of all the different budgeting options. You split your income into 3 baskets
50% goes into needs - your essentials, rent / mortgage, utilities, transport, taxes, insurance, groceries etc.
30% goes into wants - your cable, netflix, shopping, eating out etc.
20% goes into savings - investments, emergency fund, short and long term goals etc.
You could also swap the 30 and 20, if you are serious about FIRE so you save more and reduce your wants.
Tools of the trade
There are tons of budgeting tools which can help you get started. The ones I find easiest are the tools that you will always have at hand to review, monitor and check your progress. Also I would recommend using a common tool which can do expense tracking and budgeting. Makes sense for them to go together so that you know where you stand at any point in time.
I have previously recommended Spendee and YNAB apps on your smartphone. But use whatever works for you. The important thing is to stick with it.
Conclusion
Budgets are a great way to improve your financial discipline by sticking to your targets on a regular basis and build that financial muscle over the long term. If you are able to stick to your budget over 12 months, you should be well on your way towards FIRE in a decades time.
Happy Investing
Step 3: Automation - Pay yourself first
