Advisors now say that "Everyone, from students to retirees, needs to produce and live by a budget." They claim you cannot manage your affairs without one. They include the subject in their most basic course offered to high-schoolers. Garbage. Few people would actually benefit from a budget. For all those people successfully saving for purchases and retirement, there is nothing to be gained by the exercise. For most other people who need 'a nudge' in the right direction, budgeting is overkill. Those who would actually benefit from a budget are unlikely to have the willpower to abide by one. And if you don't abide by it there is no point in producing it in the first place.
Living by a budget is the same as counting calories and subtracting each mouthful from a daily limit. It is not a fun exercise. Not only is there a need for constant attention and record keeping, but there is the emotional guilt for each failure. The effect of budgeting is often to INCREASE your cost of living - for the same reasons that the person living paycheque-to-paycheque spends more to live the same lifestyle as a comfortable person. When the comfortable person sees toilet paper on sale for 50% off they stock up a full year's supply. The person living on welfare sees that same sale but cannot stock up because the price exceeds the cash available that month.
The qualification to that generalization concerns big costs that happen only once a year, for example Christmas presents, car insurance, vacations, back-to-school costs. You should know they are coming and you should save up beforehand. The easiest way to deal with these is to put aside cash each month into your emergency fund. Make a list and tally the total costs. Divided by 12 months to determine the amount to be saved each month. Prepare at the beginning of the year a schedule of the projected monthly balance of the emergency fund that reflects the base amount, plus the monthly savings, less the draws for the eventual use of the funds. Then make sure the fund's balance is kept correct.
| Emergency Fund ||Savings ||Balance|
|Jan ||pay Xmas credit card bill ||( 5,000 ) ||1,000 ||25,000 |
|Feb || || ||1,000 ||26,000|
|Mch || || ||1,000 ||27,000|
|Apr ||pay income tax ||( 2,000 ) ||1,000 ||26,000|
|Nov ||auto insurance ||( 1,500 ) ||1,000 ||31,000|
|Dec ||tuition ||( 3,000 ) ||1,000 ||29,000|
|year's ||TOTAL ||( 12,000 ) ||12,000 |
Most everyone DOES need to know what $$ they spend, and on what. This is not a budget that is prepared ahead of time to be used to limit your behavior. This is only after-the-fact record keeping. It is a necessary part of many of life's decisions. Even if your finances are in great shape, a record of your past cost of living is helpful, if not necessary, for future planning.
- It let you see where exactly you can cut back and save more.
- It determines the size of the emergency fund you need.
- It allows you to predict your living expenses in retirement, by adding and subtracting from your working-life expenses.
- It allows you to predict how much more you will be stashing away for retirement after the kids have left home and the mortgage is paid.
- It gives you feedback on the relationship between your cost of living and your pay-raise promotions.
- It provides a basis for 'the talk' when considering moving in with a new partner and sharing expenses.
- It shows you how big a mortgage you can assume without risk of default.
- It allows you to figure out how much insurance you need to protect your family if you lose the ability to work.
Your personal Income Statement looks different from what you most often see in Financial MakeOver articles. Those authors include the cash you Save in the list of your Expenses. That is wrong. You have Revenues and Expenses, just like a business does. The difference between the two is the amount you have Saved - your own Net Income. There must be a clear separation between essentials and non-essentials which can be cut back. E.g. do not put groceries and fast food in the same category. A basic breakdown may look something like the following.
| Revenues |
|Net Pay cheques (plus $5,000 RRSP deducted from cheques) ||$35,000 |
|Employer RRSP matching contributions ||5,000 |
|Separate Tax payments or Benefits received ||<2,500> |
|Other Gifts or Inheritances ||500 |
|Total Revenues net Taxes ||$38,000 |
| Expenses |
|Cash draws (less 2,000 allocated to Food at home) ||$1,000 |
|Hydro ||200 |
|Phone ||500 |
|iNet ||500 |
|Accommodation - Rent, or Mortgage payments (less $2,000 mortgage principal paid off), Maintenance fees, Insurance, Property Tax ||10,000 |
|Health - Insurance premiums, glasses, dentists, drugs, physios ||1,200 |
|Transportation - Bus passes, Taxis, Gas, Repairs, Insurance, Lease pmts ||3,000 |
|Food - eat at home - paid from cash draws ||2,000 |
|Capital Expenditures of long-life value - new car purchase, downpayment on a home, furniture ||3,000 |
|Clothing ||500 |
|Gifts and Charity ||500 |
|Entertainment - Booze, Movies, Tickets, Memberships, Sports, Eating out, Starbucks, Order in, vacations ||5,000 |
|Total Expenses || $27,400 |
| Savings |
|RRSP contributions (half deducted from cheques, half matched by employer) ||$10,000 |
|Mortgage debt principal reduction (was deducted from cash payments in Accomodation) ||2,000 |
|increase in Credit Card debt ||<1,400> |
|Total Savings - Revenues less Expenses ||$10,600 |
Like every Income Statement, this one tells a story. You need to read your own. This one shows a person who cannot save except for when others control the process for him. It is the bank that forces him to increase the equity in his home. It is the employer's RRSP contribution that provides most all the rest. This person could not even contribute the $$ to trigger the matching RRSP contribution without going into debt. A drawdown of some pre-existing savings to pay for that $3,000 (e.g.) new computer would have been OK, but not an increase in consumer debt. You pay off consumer debt and save BEFORE making any capital expenditures. The second obvious place he is over-spending is on Entertainment. Entertainment is not an entitlement.
How often you prepare your Income Statement depends on your circumstances. When your life is stable and predictable you tally up at year end. When you first move away from home into a university dorm, you would tally up each month - before you can get too far in trouble. Knowledge is power. Seeing the totals in black and white is usually all you need to realize "Geesh, I didn't realize ..... I'd better stop doing ....... I'd better start doing instead .....". Your behavior will change by itself, without any rules or anxiety.
When you share expenses with a significant other, you must agree (in principal and in action) on priorities. Too often the person worried about over-spending will assume the task of record-keeping or even budget-producing. The person actually doing the over-spending has no intention of changing habits, and may not even care. It should be obvious that the saver needs to build a financial fire-wall between the two of them. Love doesn't conquer all.
In order to prepare your Income Statement you need the data. Organize your payments in the most simple system possible so that the information is available when it comes time to tally up the totals. This may mean NOT using internet banking, or debit cards - hardcopy is quick and simple. E.g. flow all transactions through your chequing account, and log all transactions in your bank-balance-book to create a record. There is enough room on the description line to breakdown any payment into three or four catagories. At year end go through the transactions one by one, making rough lists on a page of normal paper, of the similar expenses. Then add up each list.
Think ahead how you make different types of expenses. E.g.
- Most wallets have the bills section split in two - so use one for (e.g.) fast food only. When you next withdraw cash, note in your bank book how much went into the which section.
- Use one credit card for only car gas and expenses. When the monthly bill is paid note in your bank book the breakdown between expense types.
- If one credit card is used for a wide variety of expense types, note the breakdown on the remittance slip and file that slip away until year end.
- Stuff a jar with small cash for all order-in food. Include a piece of paper (and pencil) listing it funding, which you update every time it is necessary to add more cash.
- For income tax reasons, you will be keeping records of health care costs, RRSP contributions, etc. Use that information to reallocate $$ from listed totals for (e.g.) Cash draws or Net Pay cheques revenues.
- Your mortgage statement will show the change in principal debt outstanding. Use that difference to adjust the Accommodation expense.
This exercise takes about an hour while you nurse a hangover January 1. It is not a big deal, so there is really no excuse for NOT doing it. Of course if you are the person who is not yet even balancing the cheque book each month, then ........ But that person would not be reading this page in the first place.