India is ready for FY 2015-16 with the budget. How about you? Have you looked at your finances?
How will you do financially in 2015?
- How much money will I earn?
- How much money will I spend?
- What will be my major expenses?
- How much will I save?
- Will this savings be enough?
There are a ton of articles and tools on budgeting. Today, we will look at why spending and savings are so critical. My job today, is to convince you to take a hard look at your finances for year 2015, and come up with a high level budget. At the end of it, I would like you to be able to answer the above questions.
Let’s look at our life in a very simplistic way –
- We work for 40 years – from age 20 to 60.
- We will enjoy retirement for 20 years – from age 60 t0 80.
Let’s make a couple of unrealistic assumptions –
- Our monthly expense will be the same – whether we are 20 or 60 or 80.
- There is no inflation and hence we will not earn interest on any money we save.
What does all this mean?
We have 40 years to save for the 20 years of retirement. That means, we have 2 months of working life to save for 1 month in retirement. If our monthly expense is 100, we have to save 100 every 2 months towards retirement – in other words 50 per month.
Fortunately, our assumption is incorrect. We have time is on our side. If we save and invest wisely, we will have to save less than 50 per month. This is true ONLY if we are able to get a return higher than the rate of inflation.
Hope this background helps understand why our spending and savings matter. Hence, budgeting, which is a savings and spending plan, matters even more.
How do we get started?
You can follow ‘standard’ rules like 50-30-20. Spend 50% on fixed expenses, 30% on non discretionary expenses, and save 20%. I personally do not like to use these rules as everyone of is different. Every one of us has different requirements. Instead, here’s what I would do:
- Do the home work. Before making any decisions, find out where you are at today. Go through the last few months of expenses and find out what are your big ticket expenses. Record them in big categories e.g. Food, Housing, Entertainment, Transportation, Utilities, Insurance etc. Tweak this to want makes sense to your situation. Also include a ‘catch all’ miscellaneous category.
- Look at all the debt payments you currently make – e.g. school loan, personal loan, credit card etc.
- Look at expenses that are incurred once or twice a year – e.g. insurance premium payments, membership fees, magazine subscriptions etc.
- Consider expenses that you know you will incur this year – e.g. repainting home, taking a child to a national tournament.
- Once you have these numbers, put them in Excel or track on paper in the following format.
- Calculate the total expenses for each category. Next calculate the average.
- There may not be much you can do about your fixed expenses like rent and education expenses. But you should look at the variable expenses to see what can you reduce (not necessarily eliminate) without impacting your quality of life.
- Pick 1-2 discretionary categories where you believe you can reduce the variable expenses like dining out, and see if you can do it.
- Next take a hard look at your fixed expenses and see if you can reduce any expenses. For example, if you have traditional insurance plan, consider switching to a term plan.
- By now, you should have a good handle on your expenses. Let’s look at the income side of it.
- Start with the ‘take home’ salary. Don’t consider the taxes paid and the money saved for retirement.
- Calculate the following:
- Total savings / Total income
- Fixed expenses / Total income
- Discretionary expenses / Total income
- Your obvious objectives are to reduce expenses and increase income. Instead of going by a standard formula, set your own goal for a., b., and c for the year 2015.
- Now that you know where you are at with your cash flow, you can make appropriate decisions on your investments – should you invest more in equity, pay down home loan etc.
Hope 2015 is a better financial year than 2014.
And as always, please feel free to email me at investingfunda at outlook .com for any questions you have.
In my book, ‘Stock Picking Made Easy’, you will find a simple strategy to identify great companies at reasonable valuations in the Indian Stock Exchange. Identifying great companies at the right time is the key to long term wealth creation.
Links – Apps to manage expenses