When we think of the word ‘budget’, the first thing that often comes to mind is the Union Budget of India. This is the Annual Financial Statement that the presiding Indian government presents in the month of April each year. The Union Budget affects every Indian and it is followed and dissected closely by financial experts, news pundits, and the common man. And while that budget is certainly very important, there is another type of budget that is important, albeit, on a lesser scale–the personal budget.
Why Should you have a Personal Budget?
A personal budget is, very simply put, a financial plan that apportions future income towards savings, expenses, and the repayment of debt. There is an old adage – ‘cut your cloth according to your coat’. This means that you should plan and make the best of what you have within your circumstances. Budgeting allows you to do this.
People often have a good idea about their income and a rough idea about their expenses. For example, they may ensure that they have just enough to manage basic expenses as well as certain luxuries. For them, financial planning extends to ensuring that these two are covered by their income. Details of their expenses may be fuzzy. Some may invest in stocks or mutual funds. They may have even had insurance and other forms of investments. Few, however, actually sit down and make a monthly or even annual budget. In fact, according to experts, many people would save a lot more if they made a sound financial plan.
How is Budgeting Easier for the Salaried Professional?
There is no doubt that every working individual should practice financial planning by having a budget in place. For a salaried individual, financial planning involves a different approach compared to a business person or entrepreneur. For one, having a fixed monthly income is a bonus. An entrepreneur of a start-up may face losses or a lack of regular income at least in the initial stages of their business. This is in contrast to salaried professionals who have a fixed monthly income. This makes financial planning a far easier and straightforward task for salaried individuals.
What does Budgeting Mean for Salaried Professionals?
- Set a weekly or monthly budget:
This helps you keep control over your finances in the long run. Suppose you find yourself approaching the maximum limit for a category, you can then slow down the expenditure for the same.
- The 50-30-20 rule:
For salaried professionals, budgeting should be a way to save the most amount money, without forsaking their wants and needs. To do so, you can follow the 50-30-20 rule. Here 50% of your income should go towards your essential needs and obligations. Then 30% should be put towards non-essentials; while the remaining 20% should be allocated to savings. This should be a basic rule of thumb when figuring out your personal budget. Here is the 50-30-20 rule in detail:
- 50% of income – Needs:
This category includes those bills that are essential and necessary for survival. Among these are expenses such as groceries, rent and utility bills, EMIs for home loans and/or car loans, and healthcare. It also includes life and health insurance. Now you may be wondering why insurance falls under this category since you may not even have such insurance. The reason is that life and health insurance should be an essential part of your financial planning. Insurance protects you and your family’s financial future in case of death, disability, or illness. Regular prudent savings in the form of insurance will tide you and your loved ones over in times of distress when medical bills can wipe out all savings. Life insurance is used to financially protect your loved ones in case anything unfortunate happens to you. You can use insurance to also provide a lump sum benefit at the end of the coverage period. Some insurance types provide regular income. Others may be used to provide life coverage as well as to build a financial corpus by investing in the market. There are many options available. Your life coverage should be 15–20% of your annual income.
Remember, this category does not include expenses such as dining out, a Netflix subscription, and so on. As ‘essential’ as these may sometimes seem, they do not belong here.
- 30% of income – Wants:
This category is for anything that is optional. That Netflix subscription we mentioned earlier? It belongs here. Whether it is dining out, the latest Android or iPhone, a new bag, concert tickets, or vacations, they all fall here. The ‘Wants’ category is for all the little extra expenses that make life enjoyable. This is where your budget is if you want to buy a Mercedes SUV rather than a Toyota Camry. Any kind of upgrade is allocated here. If you want to save for a foreign vacation, this is where your budget for it. Remember the vacation is a lifestyle expense. You could choose a foreign locale, or save money by going somewhere more local, within the country. You could even just skip the vacation altogether. Here is where you make and plan for all those decisions.
- 20% of income–Savings:
You must assign 20% of your income towards investments and savings. You can do this by investing in PPF, stocks and shares, mutual funds, and so on. This category also includes having an emergency fund in a savings bank account. Here is also where you save up for your golden years. Your retirement corpus should be at least 20–30% of your annual income. This category of ‘Savings’ also includes debt repayments. For example, you have an on-going home loan repayment. The EMIs for this loan fall under the first category of Needs. But any additional payment that reduces the principal and future interest amount falls under this category as it saves money in the long term.
- 50% of income – Needs:
The 50-30-20 rule is a guiding principle. While it is a great place to start, you may need to adjust the percentages based on your personal circumstances. For example, if you live in a place where the cost of living is extremely high, a 60-20-20 budget could be more appropriate. If you are a very high-income earner, the proportion could be adjusted to 40-20-40. Assess your personal situation and apportion your income and expenses accordingly.
- The debt to income ratio:
Banks and home loan providers use the debt to income ratio to determine if a home loan should be provided to an applicant. This can also be used to manage your personal finances. Here your expenses should not be over 28% of your gross income and should be less than 36% of all existing debt.
- Goal setting:
When planning your budget you should set your financial goals in place. There should be three-time frames—short term, mid-term, and long term. Short term goals range from a few months to a year. Mid-term goals range from one to five years, while long term goals entail plans that are over five years away.
- An emergency fund:
Emergencies can happen anytime and can vary in circumstances. What remains constant is that any emergency requires immediate action. For example, your company may close down, leaving you unemployed for a few months. Or you may meet with an accident and the settlement of the claim could take some time. Whatever it may be, having the required funds is imperative. The emergency fund is not to be used for meeting planned goals, but to act as a financial safety net. Ideally, you should keep aside three to six months’ worth of household expenses towards your emergency fund.
- Reduce debt:
Today, getting a credit card is easier than ever. Unfortunately, this has led to an increase in debt, specifically credit card debt. Having a credit card tends to make people overspend. You should use your credit card as a means to make payments going into unnecessary debt. Avoid using your credit card to rotate money. Controlling your credit card habits will go a long way in managing your budget. Do not take more credit than what you can repay within a month’s time.
- Make maximum use of tax-saving instruments:
Preparing an effective personal budget involves making full use of tax-saving instruments available. These include life insurance, tax-saving mutual funds, and so on.
- Diversify all investments:
An important aspect of investing is diversification. Don’t put all the proverbial eggs into one basket. Diversification of investments will help buffer market volatility to an extent. Your investments should include both long term and short to mid-term investments.
The bottom lLine
Budgeting is not a ‘one size fits all’ deal. Your personal circumstances will determine how you approach your personal budget. The thumb rules mentioned above can and should be amended to suit your needs. Remember, you don’t need to live sparsely and not enjoy life. Budgeting will help you to cover your expenses, save for a rainy day and retirement, as well as plan for little or big luxuries along the way.