Personal Finance: Budgets and Systems
Financial security is one of those weird things in life: everyone want its, but very few people try to systematically achieve it.
Why? It’s probably a combination of the following:
- confusion: a lot of finance language is impenetrable
- fear: if we don’t look, we don’t have to recognise any problems
- shame: we’re taught not to talk about or prioritise money
It’s easy to look away and stay on autopilot, but hopefully this guide will help you start your journey to being more engaged in your financial life.
The goal is not disabling the autopilot, but to actually setting the destination. Don’t just see where you end up.
The first step is easy though:
Destination, destination, destination
To push the metaphor a bit further — where are we trying to get to? You need a destination in mind to plot a route. “Somewhere nice” isn’t enough for your SatNav to work from, so “better” isn’t good enough for your financial life.
In practise we want the following:
Any unexpected event can be afforded. You can focus on making the best choice, instead of the immediate choice.
You are secure and your lifestyle is stable if:
- Car issues? You can afford a repair, or down payment on a new car
- Landlord wants to sell? You have a deposit and money for moving costs
- Lose your job? You have enough to survive a few months whilst you find the right next job
The unexpected should not cause things to spiral out of control, or a have a large impact to how you live. You should be able to be strategic with no need to borrow from friends or family to keep your head above water.
This is the aspiration means being mostly debt free and having a reasonable emergency fund. It may not be 100% achievable for everyone at all times, but that’s okay. Sometimes too many things happen at once, or trade-offs to get there might be too much (you need live as well, not just exist!). The important bit is our decisions are guided by a desire to reach this goal.
Now we have a destination - how do we get there?
Step 1: Where are you starting from?
The first step of planning a route is understanding where you are. There are many tools to help you do this. The goal here is to know the following:
- How much cash do you have and where is it? (current or savings accounts)
- How much debt do you have? What is the interest rate? (credit cards, overdrafts, loans)
Once you have these, write them down. Figure out what the net value is (cash minus debt), this will help us know how far we need to go.
(Although assets impact your total net worth, as they aren’t liquid you can’t use them to cover an unexpected cost. Don’t include home value or pensions. Do not include mortgages or student loans either as they are fixed costs you can’t do much about in this context.)
Step 2: Whats your direction of travel?
The next step is understanding how your finances are changing month-to-month. How fast are you able to save? This will give you an idea of how far you need to go, and highlight if you’re further away than you thought.
The easiest way to do this is using the many of free tools out there. I use Yolt get an overview of my accounts and spending:
Some of the modern banks like Monzo also offers features to do this, or to support data exports to let you do it yourself (though this may not be free).
Get a rough idea of what you spend each month on different things. This is your current budget, whether you chose it or not.
Start by listing the fixed costs, then your 3 month average for everything else and call it “discretionary”. This is everything you choose to spend money on throughout a month, so it is the most flexible. This includes going out, shopping, groceries etc.
You should now know your income and monthly spend, so you can determine the difference. Hopefully it’s positive! If not, you will need to make some hard choices on what to reduce (or alternatively, how much more income to find).
Step 3: How much is enough?
Now you know how much your lifestyle is costing, you know how much you would need to maintain it for a few months. As a rough starting goal, multiply your outgoings by 2 or 3. This is now your emergency fund target.
Some advise up to 6 months, however this is down to your own risk tolerance. One important note: this money is ring-fenced only for emergencies.
This money must not be used for wants! This is for when your car explodes, not because you fancied a new one. It must not be borrowed from for things like holidays.
Keep this money in an separate account, away from all your other savings and current accounts. Savings are easiest to not spend if they’re out of sight so out of mind.
Should I prioritise paying off debt or building my emergency fund?
These is much debate about this one — it depends how high your interest rates are accord to experts like Martin Lewis.
Essentially if the interest rate on the debt is higher than the interest you would get on the savings, you should pay off the debt. As you can always use up the credit you’ve paid back in an emergency but you’ve avoided extra interest in that time.
Step 4: Build a budget, set up systems
Initially I hated writing out a budget. I avoided it for all of university, and finished that with only £50 of my £1750 overdraft left… Now I’ve been doing it for a few years I actually enjoy it and really value the confidence and security it gives me.
The most important thing to do is pick realistic amounts for your spending. If you constantly go over, up the value. A budget that doesn’t reflect reality is useless.
Building a budget forces you to actually choose what is important to you.
The good thing is we already have a scaffold — take the unconscious budget you wrote previously and start breaking down the “discretionary” category.
- How much do you want to spend on groceries?
- How much do you want to reserve for fun money?
- How much do you need to keep aside for clothes and other essentials?
- Can any of the fixed costs be reduced or removed?
These numbers will evolve over time as you get used to your budget. It will flex to fit your goals as your circumstances change.
Strategies for easier budgeting and saving
Here are a few techniques I use myself:
- Different accounts for different uses
Have different accounts for day-to-day spending, and another for fixed costs like bills. If you’re a couple I would recommend doing the same as well: a day-to-day each plus a joint for bills and a joint for shared expenses like meals out and groceries. This is very easy to do now that there are many modern app-first banks.
- Pay yourself a weekly wage from your main account
It’s a lot easier to think about a week when it comes to handling day-to-day spending. Set up a direct debit from your bills account into your day-to-day account. This way you don’t need to look at the pile of cash in your bills account.
- Automate your savings upfront
Know how much you will spend in the month, then send all the rest the cash (minus a small buffer) to your savings account at the beginning of your pay cycle. There should be some friction for overspending.
Keep it up! Once you have a structure figured out things get easier. Check in with you new system every few months to see if you need to adjust anything, or if your priorities change.
Once you have got your emergency fund at a level you are happy with, you can choose what to do next with your savings. Be that a big holiday, a new car or a deposit on a house.
If you have nothing else to aim for consider either keeping more in high-interest cash accounts, or investing in the stock markets if you want some larger (but riskier) long-term growth.