You earn well but cannot save. You don’t know where your salary is going. Sometimes you have to borrow to pay your bills. If any of these statements apply to you, it’s time to write a family budget.
Many people are put off by the word budget because they associate it with spending restrictions and a frugal lifestyle. This is a misconception. Budgeting doesn’t make you spend less, but lets you spend smart. “A good budget allows you to focus your money on the things that are most important to you,” says personal finance expert Carl Richards. By preventing you from overspending on less important items, a budget funnels resources to areas that should be prioritized.
In the post-demonetization economy, tracking spending isn’t very cumbersome. But the use of plastic and other cashless fashions means overspending can be a problem. This is where budgeting apps play a vital role. They help track your spending and alert you if you exceed certain limits. Beep! if you exceed the limit for dining out. Beep! beep! If you swipe your card too many times in the clothing showroom. Don’t underestimate the usefulness of this feature.
Over-spending on restaurant meals and clothing is the most common reason young people are losing their golden years of composition. If you save Rs 10,000 per month in an option that pays 10% per year, your corpus after 30 years would represent a crore of Rs 2.16. But if you start five years late at 35, your corpus will be around Rs 96 lakh smaller. Derailment of financial goals is not the only problem. Shopaholism can ruin careers, destroy relationships and cause discord in married life.
An online survey conducted by ET Wealth found that overspending was the most common reason for couples’ money disputes. The problem was very pronounced (52%) in young couples under 30, and gradually decreased (34.9%) in older people after 40 years.
As we all know, the profusion of choices offered by online retailers and the convenience of online payments has led to an overbought epidemic in India. Most buyers, especially younger ones, don’t realize that every unnecessary purchase pushes their long-term goals back. “Shopping is not a vice, but it can become a problem if the expenses prevent the individual from saving for essential financial goals,” says DP Singh of SBI Mutual Fund. Budgeting can avoid such situations. It prioritizes your expenses and allocates resources so that all your financial commitments are taken into account.
Research shows that households that follow a budget save more money than families that don’t have rules. This is simply because if a family has allocated money for the investment, that amount will automatically be invested each month. On the other hand, the family without a budget will tend to spend too much money on discretionary items and put long-term goals on the back burner.
If you still think you don’t need to budget for the family, click here to take a little quiz and find out if you’re right. This will give you a good idea of where your finances are headed and what you need to do to get the situation under control.
The first step in budgeting is to write down the different sources of your income. This includes salary, rent, interest on deposits, dividends, etc. Then make a list of expenses incurred over the course of a month and allocate money to each of these leaders. Include everything from the grocery bill to what you pay the maid, from fuel expenses to the car’s IME.
Everything that is paid should be in the list. For some expenses, such as tuition or insurance premium that are paid quarterly or once a year, you may need to calculate the monthly amount. There is a widely used 50:30:20 budgeting rule. This back of the envelope principle says that 50% of your income should be used for essential expenses (food, shelter, clothing), 30% should be used for discretionary spending, and 20% should be put into savings.
But this is not a foolproof allowance and may vary depending on individuals and financial circumstances. Those with expensive home loans may find that their housing cost is almost 50-60% of their income. We looked at the spending pattern of the average middle-class urban Indian household and changed the formula to be 60:20:20. Compare your own expense breakdown to find out where you stand.
How a family should spend each month
Here is how much a household income of Rs 1 lakh per month should be allocated under different headings.
Essential expenses: 60% of income should be spent on these essential items.
Food and groceries: 18.8%: Rs 15,000
Health (including insurance): 4%: Rs 4,000
Life insurance: 3%: Rs 3,000
Housing: 20%: Rs 12,000
Utilities: 4%: Rs 4,000
Education: 6%: Rs 6,000
Transport: 8%: Rs 8,000
Clothing: 7%: Rs 7,000
Savings: 20% should be invested for financial purposes
Discretionary Articles: 20% of income can be spent on discretionary items.
Entertainment: Rs 10,000: 3%
Communication (including TV, internet): Rs 3,000: 3%
TOTAL: Rs 1 Lakh: 100%
Set limits for categories
In addition to the general limits for each type of expense, there are sub-limits for specific categories. Your monthly expenditure for loan repayments should not exceed 50% of monthly income. This is also the reason why lenders carefully examine your bank statement to see how many EMIs you serve before giving you a loan.
It doesn’t matter if your IMEs are up to 50% of your income if they include one for a home loan. But automotive IMEs should not exceed 15% while personal loan IMEs should not represent more than 10% of net monthly income. If your EMPs swallow up too much of your income, other critical financial goals, like saving for retirement or your children’s education, could be affected. Retirement planning is often the first to be sacrificed in such situations. The good part about budgeting is that if the EMI is factored into the monthly expenses, it will get paid on time.
If you are on budget, you won’t have to worry about EMI payment or credit card payments. Budgeting will ensure that there is enough money in the bank to pay the EMI and meet other financial commitments. It can give you relief and transform your financial future. As with loan repayments, there may be other sub-limits such as life insurance expenses. Ideally, the cost of an individual’s life insurance should not exceed 2-3% of income.
Someone who earns Rs 6 lakh per year will be able to purchase adequate insurance coverage for Rs 12,000 to 18,000. However, this will only be possible if he opts for low cost term insurance. Any other form of life insurance will swallow up too many premiums and not adequately cover life. An endowment or repayment plan with life coverage of Rs 10 lakh will have an annual premium of around Rs 80,000-1 lakh.
Keep it flexible
The best budgets are those which allow a certain flexibility in the household. If you have money left in a category, it should be used for expenses where you are facing a shortfall. The only exception to this rule should be the money spent on the investment. As a general rule, this money should not be used for any other category, except in cases of extreme urgency. This will ensure that overspending does not hamper your financial goals. Even so, future financial goals bear the brunt of overspending.
One way to make sure your investment plans don’t fall apart is to automate them. Start a SIP in a mutual fund (or a recurring deposit in your bank if you’re risk averse). The ECS mandate with your bank will ensure that the money is invested in the mutual fund on the due date each month.
Your financial forecasting tool
Once you start following a family budget, it can be a useful tool in financial planning. In about 2-3 months, you will notice a trend in your spending that will tell you where you need to cut back or how you can get the most out of your money. Your savings model will allow you to plan for short- and long-term financial goals, such as a vacation, a new car, or your child’s education.
Your budget will tell you exactly how much you would have saved for those goals in the allotted time. A family budget is a guide that helps you live within your means. However, it should not be based on faulty assumptions and incorrect information. A budget that is too ambitious or impractical may fail.
Also Read: Mistakes That Can Derail Your Household Budget