Financial cornerstone: budgeting and saving
Budgeting and saving is the cornerstone of managing one’s financial affairs. A budget is an estimation of likely income and expenditure over a defined period of time, such as a month, quarter or a year. Savings is the difference between income and expenses. A successful combination of both a budget and savings plan is a sure way to foster financial independence and wealth accumulation.
Having a goal is the starting point of any sound financial plan. Goals are personal and come in different forms, sizes and levels of importance. Forms of financial goals are long-term, medium-term and short term. Long-term goals usually involves saving for large investments in five or more years; usually for retirement, downpayment on a house or college education for children. Medium-term goals are from 24 to 60 months, and may include the funding to purchase a car or get married. Short-term goals are from zero to two years and may involve establishing an emergency fund to cover six to twelve months of living expenses or to reduce high cost consumer debt such as credit card and hire purchase debt.
The main goals of savings and budgeting are to spend less than you earn, and to know what you are spending your hard-earned money on. Individual incomes are usually fixed, hence the need to spend carefully by distinguishing between needs and wants. Our needs are food, clothing and shelter; everything else is a want and can be cut from our budgets to increase our savings. Additionally, we should scrutinise how we fulfil our needs, as it involves a lot of choices which can be budget busters. Shelter, for example, can be a four bedroom house in Portmore for $10 million or one in Barbican for $60 million. Similarly, clothing could be the difference between Louis Vuitton and Levis.
There are many ways to construct a budget, from the traditional budget of listing all our revenues and expenses, which is great for the detailed oriented person, to the simple plan of allocating different percentages of one’s income to needs, wants and savings. The latter is preferred by creative and busy persons. The 50-30-20 simplified plan dictates allocations to needs, wants and savings respectively.
Arkad, the rich friend of Bansir and Kobbi in the classic financial literature book The Richest Man in Babylon taught that savings, or paying yourself, is the first lesson in attaining wealth. The amount to save is dependent on your current financial situation, but it should not be zero. Ideally, putting aside 10 per cent of gross income earned or any small amount is ideal for attaining life’s goals.
Effective savings strategies include salary deductions, increased pension contributions and allocating funds for different purpose to different accounts. Salary deductions takes away the hassle and temptation to spend one’s wages as savings can be automatically transferred to an account set up for a particular purpose; such as buying a broad-based (indexed) mutual fund, payment of an upcoming insurance premium or taxes. Higher pension contributions is an excellent way to meet the goal of savings for retirement income as it increases your retirement nest egg, while lessening our current tax payment; a double win.
Finally, Keeping Up with the Joneses and the Hedonic Treadmill, where we quickly adjust our lifestyle to improved circumstances, such as a pay raise, are detrimental to budgeting and savings. It is important to remain focused on your goals throughout budgeting and saving. This discipline develops healthy financial habits and will help to realise your specific desired outcome.
Gladstone Wynter is a wealth advisor at Stocks & Securities Ltd. Contact: gwynter@sslinvest.com