Budgeting
What is Budgeting and Why is it Necessary?
The most important way to generate wealth is to live within or preferably below your means. This can be done by keeping an eye on your money flow. The use of a personal budget is the simplest and quickest way of analyzing your cash flow, and understanding whether you are a spender, or a saver.
A budget is a periodical plan that helps its maker to allocate their incomes towards their expenses and fixed obligations.
Maintaining a budget is important because -
- Your budget will help you monitor and track your money flow on a month on month basis.
- You will be able to see how much of your money is spent on necessities, and how much on luxuries.
- After practicing your budget for a while, you will have greater awareness on where your money is going and you will be able to streamline your expenses to increase your investments, ultimately building more wealth.
- A budget will make it easier for you to evaluate your cash flows for the month and see how your money is flowing between your four segments.
How to Make a Budget?
Step 1: Be aware of your Net Monthly Income (post tax)- Apart from your salary, you could be receiving income from rent, dividends, interest payments, etc. Keep track of all these alternate incomes post-tax as well.
Step 2: Make note of your Expenses- The main Expenses that show up in everybody’s budgets may include:
- Grocery bills
- Spending on children’s school / college tuition fees
- Shopping and entertainment, including eating out expenses
- Electricity bill
- Travelling / fuel expense
- Telephone and cell phone bills
- Medical expense
- Miscellaneous expenses like society charges (if you own a home), etc..
Step 3: Keep track of your Liabilities- The main Liabilities that people can have are:
- Home Loan (the biggest and longest EMIs you will ever have to pay)
- Education Loans
- Car Loans
- Personal Loans
Cash outflows that go towards repayment of existing liabilities such as home and car loans, are funding the respective asset purchases. For example, EMI payments are regular, and are significant outflows from your monthly income. Be aware of the rate of interest on each of your liabilities. Stay updated on whether you can avail a better rate elsewhere, and whether you can negotiate a better tenure after sourcing your loan from another bank.
Step 4: Invest your Net Free Cash to build your wealth- The free cash you have left after your expenses are taken care of is your net free cash. This is the money that will go towards building wealth for your financial goals and accumulating assets. It is these ‘leftover’ funds, also known as your “investible surplus” that will build your wealth.
So if you find yourself in a situation where your investible surplus is low, or close to nil, you need to very quickly rectify the situation. The only way to do that is to cut back on unnecessary expenditures. Remember – it is better to first invest, and then spend out of what is left, rather than to first spend, and then invest out of what is left.
