Studies of Life

Learning by doing.

Budgeting is Important and Easy, so Start Now!

23 April 2014 by Jim

You need not only earn money, but also decide what to do with it. The decision is important. There are no preset rules as to what your budget should look like, but it’s important to think about it and develop a plan.

The first step to being financially independent is proper budgeting.

Why? Because you need to know how much money comes and how much goes out of your pocket to know whether your current situation is sustainable or not. If it is, great, see if you can improve it, if not, change your situation to make it sustainable, before life changes it for you.

If you want to invest, you need to save money first (don’t, in any case, borrow money to invest, in fact, don’t ever borrow money if you can help it). That may sound like a trade-off since you can’t immediately spend that money, but think about it this way: if you invest 1000 € at 7% annual ROI right now, you’ll have 2000 € in 10 years. If you spend these 1000 € now instead of investing / saving them, then, to get the same net effect on your net worth in 10 years, you’ll have to have twice the initial 10000 € in 10 years. It’s essentially free money, since you didn’t have to work for it. (No, investing, although it may be an activity and/or a hobby is not the same as working for your money.)

At least when you’re still young, most of your income should be saved and dedicated to long-term wealth, not short-term pleasure. Unfortunately, most people’s brains seem to be wired for the exact opposite. It’s not so much about saving all the money you make, it’s about having a precise plan and making progress towards your financial goals, however slow it may be.

In any case, it’s wrong to live pay check to pay check. If you accumulate a certain amount of debt, beyond which the banks don’t let you borrow anymore, you have to stop and pay (at least some of it) back. When that threshold of ‘too much debt’ is reached, you effectively stop spending so much. So, if you are able to stop spending when you’re forced to by a bank, why don’t you just stop spending so much before that happens? Most of the things people think of as necessary expenses, including cars, rent, restaurants and entertainment, are completely unnecessary. They’re just lifestyle objects, conscious choices you make that are in no way compulsory. This doesn’t mean you have to live like a monk, but you can reduce the amount of expenses you have quite dramatically if you choose to:

  • ride the bus instead of a car,
  • have a roommate instead of an own apartment, and
  • watch movies with friends at home instead of going to the movies.

Some of these things are easier to do when you’re young and your situation changes a lot anyway, but none of them are impossible to do once you’re older. Even if you’ve lived for 20 years with a shiny new car every 2 years, who says you can’t buy used ones for the next 10 years to save money? You’re free to do as you please, for better or worse. Please don’t make it worse.

Right now, since I’m still living with my family (in my early twenties, that’s still acceptable, I’m told), I can reduce my holiday, food and entertainment budget to about 10% of my income, a full 90% of it is being invested every month. That is a huge load of cash that’s slowly piling up behind me if I ever need it, just like a huge load of debt is piling up behind those people who choose to spend (more than) their money right away.

The money you save is similar to a specific quantity of time you have in your bank account. If your net worth is 0, then you have to work all the time to pay your bills, without any freedom to decide what to do with your life beyond work. If you have a net worth that covers 5 years of your expenses, you can, whenever you like, take a 5 year vacation. You can change your job whenever you feel like it, and you’re free to do as you please.

That is freedom. The key to saving a lot of money is to get into a situation where money is not your main source of happiness, so that saving a large part of your income won’t feel like something negative. If you get most of your pleasure from being with friends, from hobbies like reading, painting, sports or simply enjoy having a cup of tea like I do, that is priceless.

It’s always easier, later on, to go up the lifestyle ladder and spend more money, than start spending less because crippling debt forces you to. So don’t adjust to new-found wealth right away. If you get a promotion, don’t spend all the additional cash in your salary. Put it away, save it, invest it, do something intelligent with it, but don’t immediately make this salary ‘barely enough to live on’. Most people do, and when they ever lose a job or face some other financial problem, they are in for a huge amount of pain.

A great trick to automatically budget is to have your salary immediately split up by your bank into different investments – automatic wire transfers to investment or savings accounts, for example, or special sub-accounts for specific purposes. For example, I have a specific holiday account that I put a small amount of money in every month. That money is, for all intents and purposes, gone. It cannot be used for anything besides paying for holidays. This way I’m sure that my monthly budget for holidays does not grow uncontrollably, I always see how much money is available to spend. If there’s no money, there’s no holiday. But if there’s a holiday, my regular accounts and credit cards are not affected at all by the expense.

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