1. SIMPLE BUDGETING
The simplest form of budgeting is “Pay yourself first”. I believe that all of you would have heard of these 3 words. This budgeting rule splits our income into 2 parts; (i) pay for our future self and (ii) pay for everything else.
Besides this, another popular budgeting rule that was often brought up is the 50/20/30 rule. This rule is an improved version of the earlier rule. This rule essentially means that out of the 100% take home income that you have, spend 50% on your needs (e.g. food and shelter), 20% on savings (pay your future self) and the remaining 30% on your wants (e.g. entertainment).
2. ADVANCE BUDGETING
From my experience, the problem with the earlier 2 rules is it doesn’t provide a clear guide on what are the essential expenditures and how much one should include into their budget. For example, an insurance is clearly a “Need”, however, I have seen clients spending 20% to 30% of their take home income on insurance premiums.
Hence, I adopted the 2116 rule. Out of the 100% of your take home income, spend:
- 20% on long-term investments for retirement planning purposes
- 10% on short-term savings (first accumulate your emergency funds, then other short-term goals such as vacation)
- 10% on insurance premium
- 60% on everything else (other needs and wants)
I have been using this rule for many years now. Of course, this is just a reference. Some clients of mine have existing fixed commitments that is difficult to cut, hence, they are only allocating 10% for long-term investments. However, as long as we do our best and increase the allocation towards long-term investments, we will eventually reach our goals.
3. EXPENSE-BASED BUDGETING
Ever since I started tracking my expenses, I have been slowly changing my budgeting approach.
In all the earlier mentioned budgeting rules, they share something in common, i.e. they are all income-based budgeting. You start your budget with your take home income and plan where should you allocate the money.
However, I have been testing the expense-based budgeting strategy recently, and it has been working out great for me.
To start the expense-based budgeting, the pre-requisite is to track all your expenses for at least one full month (preferably 6 months). The key is to spend as per usual and do not ‘compromise’ to make your expense report look ‘healthy’.
When you have all your expense recorded, you may now start to set a budget for every single expense. Review on a monthly basis if it is possible to reduce the budget to each individual expense so that you can allocate more money into long-term investment.
As mentioned in my earlier article, the benefit of combining both expense tracking and budgeting allows me to be set mini challenges every month to find ways to save more without compromising my quality of life.
The above budgeting rules are derived from my personal experience, and there are more budgeting strategies out there on the internet.
However, no matter which approach do you adopt, it is very important to start now. If you do not have a comprehensive financial plan, having a basic budget is the least you can do to improve your personal finance.
In the next post, I will share my thoughts on what makes a great budget.