Musing 7: The Only Way to Budget

MUSING 7: THE ONLY WAY TO BUDGET

DON’T BE PENNY WISE AND POUND FOOLISH

If there is one activity from conventional financial wisdom which is universally hated and thus NOT going to work, it is budgeting. I have tried all conceivable methods for budgeting - from very rudimentary to the most complex and trust me, they all don’t work. After weeks and mostly days of counting and accounting pennies, you stop budgeting altogether in sheer exasperation. However, after trial and error, there are two techniques I have found that work, and honestly these two are the only ones which are required to have a smooth monthly budget. Let’s discuss them one by one.

Zero Based Budgeting (ZBB)

Before we discuss ZBB, we should remember that budget is nothing but a plan to tell your money where to go instead of wondering where it went? The fundamental behind the ZBB is that there can be no ideal month so far as your expenditures are concerned. Even for planned expenses, and fairly large ones, like school fee, car insurance, festivals, vacations et al. one needs to cater for, depending on the months that they fall in. What further adds to the complexity is that even your pay is not constant each month. Deductions, Income Tax etc. will vary this amount as well. Keeping these two factors in mind one has to budget for each month afresh keeping the expenditures lined up for the month in mind or in other words assigning every Rupee a name and place to go.

We are clear that we have put 20% of our money towards investments (save bucket) which is sacrosanct and are thus working towards our Needs (50%) and Wants (30%) buckets here. ZBB, done around a week before the next month starts, stipulates that each and every prospective expenditure is first accounted for and then a rupee value assigned against each.

For ZBB, one can create five basic heads under Needs column viz Food, housing, transportation, utilities and clothing. So, if you have to pay your house rent in the coming month which is Rs 10000, then against the item “Rent” write Rs 10000. Similarly, all other likely expenses will be accounted for and a Rupee amount assigned to them.

Similarly, a column for Wants will be created containing all possible subheads like outings, movies, new Jeans, gym membership fee and so on and Rupee amount assigned against each. Now, you know, a full week before the next month has to start, that you need X Rupee amount on 01^st of the month (assuming that you get paid on 01^st of each month) for your Needs and Wants. On 01^st of the month, there could be three contingencies-one that the pay will be exactly the same as the required amount (unlikely), the other two would be the pay being less or more than the required amount.

If the pay is less than the required amount, some trimming from Rupee amount of Needs and Wants needs to be done. As we discussed in the musing on SI balance, the wants are the ones which will have to be pruned down first. For example, if the pay is less by Rs 2000, the Jeans that you had planned to buy this month will have to wait for one more month or you cut out one outing out of four planned for the month. The type of want that will get omitted will differ from person to person and their aspirations. The bottom line is that the Rupee amount will have to be trimmed down till such time that the expenses equal the pay for the month.

If the pay is more than expenses, it is not treated as free money to be spent on discretionary spendings. You need to tell this extra money in advance, as to where it should go. So, if you manage Rs 2000 extra in the pay, you may decide to buy two Jeans instead of one or give a surprise treat to your wife or simply create a reserve for a rainy day. Whatever you do is your decision but should be a well thought out one.

Envelope System

This is a corollary of the ZBB. One has to create envelopes for various expenses like “groceries”, “vegetables”, “school fee”, “gas cylinder”, “outings” and so on. Once the Rupee amount of each is decided upon, withdraw the amount from bank and keep in the relevant envelope. Yes, this system requires you to deal in cash as much as possible. One keeps spending from the relevant envelope as the month progresses and once the money from the envelope is gone, it’s gone. So, if the money from “outing” envelope is over on 20^th of the month, no more outings for next ten days.

One can sense an immediate reaction from you- carrying and spending cash in this age of plastic? Why not decide the amount and then keep paying by card. The reasons are like this: firstly, it is difficult to keep track of the expenses by card and one can easily end up overspending. Secondly, card swiping doesn’t invoke the pain of parting with money as much as counting the cash and handing over to the shopkeeper/vendor. The situation will be worse with a credit card where one will invariably end up overshooting the monthly budget thus spending out of next month’s pay.

The issue of expenses which can be anticipated for the entire year like anniversaries, birthdays, annual tuition fee for the child, vacations, festivals etc. should be planned slightly differently. If you intend spending Rs 50,000 on your yearly vacation, simply divide this amount by 12 and save Rs 4,000 (approximately) every month. Keep putting the money in a liquid fund through SIP or open a Recurring Deposit in bank for 12 months maturity (we will look at these issues in depth later). This way, your dream yearly vacation will be catered for without impacting your budget for that month.

Key Chapter Takeaways

·        The 50% (need) and 30% (want) buckets should be budgeted using ZBB       and Envelope systems.

·   An accurate assessment of all likely expenditures, monthly and yearly,   should be done right in the beginning of the year and month as the case may be. The yearly expenditures like vacations, anniversary, festivals etc. should be assigned a Rupee amount and divided by 12 to get a monthly amount. Each month, this amount should be set aside as part of the Wants (festivals, anniversary etc.) and Needs (school fee, car insurance etc.) bucket.

·      The monthly occurring expenditures should be adjusted against the monthly pay, beginning with cutting the Wants amount, if the pay is less than the expenses.

Enjoy your weekend, you have earned it.
Cheers.