Is the art of saving up for a purchase dead in today’s world of instant everything? Instant coffee, instant messaging, instant meals - instant gratification! We’ve all had that feeling where we need the newest, shiniest thing to reward ourselves for a job well done. But that impulse to buy can really put a dent in our financial plans and even derail more important long-term goals. Budgeting doesn’t mean you have to deny yourself, but it may help you quantify and prioritise your spending, making your financial goals more attainable! - Patrick Ball, Private Banker for RBC Royal Bank (Cayman) Limited
Anyone at any age can benefit from taking control of their expenses. Think back to when you were a kid. You probably remember a time when you had Mrs. Bradshaw’s math test to study for and debated whether to use your weekend for studying or to go out with friends.
Well, if you budgeted your study time and developed a study plan, you’d probably realise that putting in consistent hours in the proceeding weeks would help ensure you could go out and enjoy your weekend without feeling stressed!
In that respect, we like to think that with the proper plan (or budget) in place, you can have it all. You’ll become more efficient with your time and your money, too!
A budget is defined as a spending plan for a specified period, such as a month or a year. In its simplest form, a budget estimates how much money you'll receive (income) and spend (expenses) over that period. It can be useful to categorise your spending into buckets, like entertainment, groceries, clothes, transportation and dining. Its purpose is to create financial stability by allowing you to determine in advance whether you will have enough money to do the things you need or would like to do. In other words, it helps you distinguish between the true needs versus the wants in your life, and then aids in prioritising those wants.
Creating and sticking to a budget is key to financial success, but it can also result in feelings of stress and anxiety for many of us. Start with the basics and keep it simple. Some people prefer to write their budget by hand, while others use a spreadsheet or budgeting app. There’s no ‘one-size-fits-all’ way to budget — what works for one person might not work for another. The best way to learn what works for you is to give it a try and remember that you can adjust and adapt along the way!
When it comes to allocating income, we think the 50/30/20 approach is a good place to start. This method suggests you spend about 50% of your monthly after-tax income on necessities, 30% on wants and 20% on savings and paying off debt.
Let’s take an example from two people who earn similar incomes but have drastically different spending habits - Alicia and Brian. Brian has five times the savings of Alicia but spends 50 times what Alicia does. Brian will burn through his savings in just 10 months as opposed to 100 months for Alicia.
Take a look at the table on the left. It showcases the importance of understanding the spending implications on the budget and adjusting them accordingly to suit the needs of the identified goals.
What Makes a Successful Budget?
A budget should include estimates for income, fixed expenses, miscellaneous expenses, as well as clearly defined personal financial goals, from near-term emergency savings to long-term retirement savings.
These goals should be 'SMART':
Specific - Add a monetary value to a goal as well as an overarching purpose.
Measurable - A more accurate forecast/goal will make it easier to measure the ultimate success.
Achievable - The more attainable the goals, the greater the probability of success.
Reviewed - Regular reviews of budgets with adjustments where necessary.
Timely - Include a pre-specified period for attaining the goal(s) even if this is subsequently adjusted.
Real World Example
I’m sure you’ve all heard those dreaded words, “Mum/Dad my best friend’s parents got this for her. Why can’t I have one too?”
One way to instil some early financial literacy might be to ask your child to prepare a budget with their allowance as the income. Ask them to budget their monthly expenses (or wants) for a period of one year - the ultimate goal being the purchase of the item they want at the end of the 12 months.
This budget should be reviewed monthly to assess if they are on track and brings the opportunity to teach compound interest.
To simplify the concept, absolute numbers (in $5 increments) can be used instead of the actual calculation for compound interest. For example, for every month the savings goal is achieved, an additional allowance of $5 (and increasing in $5 increments) could be awarded. Assuming they remain within budget for months 1-3, the additional allowance in months 1, 2 and 3 would be $5, $10 and $15, respectively.
However, if in any month your child does not meet the budget, no additional allowance is awarded. So, if the budget is met six times over 12 months, the additional allowance paid would be $30, which lines up with month six and a cumulative additional amount earned for the year would be $105.
Compare this to achieving the budget in all 12 of the months, which nets a cumulative additional allowance of $390. Whilst meeting the budget 12 times represents a twofold increase over six times, it results in nearly four times the additional amount earned: $390 vs $105.
Remember, budgeting can benefit everyone. It encourages us to live within our means, understand our relationship with money and save for the future. Think of a budget as building blocks to your and your children’s financial goals!