This article is taken from Merryn Somerset Webb’s free weekly personal finance email, Money Sense. Click here to sign up now: Money Sense
Looking back on my school days, I remember absorbing huge dollops of literature and science, which have served little purpose since other than enabling me to answer the occasional pub quiz question. At no point do I remember being taught one if life’s most vital financial survival skills – how to budget.
And it’s a skill that we’ll all need going forward. In the past few years, easy credit and the bottomless piggy bank of mortgage equity withdrawal, have left the concept of a personal budget looking not just a bit dull but, worse, irrelevant.
But times have changed. As Ernst & Young’s Andrew Wollaston put it in The Sunday Times last week: “consumers are cutting back and the pressure is beginning to build”. Our personal finances are now under assault from all sides – rising utility bills, mortgage interest rates and food prices being the prime suspects. Chances are these cost pressures will get worse before they get better – just this week the producer price index recorded its strongest rise for 17 years, hinting at more inflation in the pipeline. And all this at a time when the CEBR predicts up to 20,000 job cuts in the City.
So if you’re not already on top of your personal finances, now’s the time to do it. It takes a bit of effort at first, but it’s worth it – and not just from a financial point of view. Money worries are cited among the top five reasons why nearly half of UK marriages now fail, according to the Office of National Statistics. So not only could effective budgeting save you money, but it could also make your life a lot less stressful – and maybe even improve your relationships.
Budget planning: basic principles
The key skill required to make budgets work is discipline. The process itself is then straightforward – the aim is to capture your monthly income and expenses as accurately as possible and then look at the difference. If you are spending more than you receive, you need to work out how to either boost your income – tricky unless you are planning to negotiate a pay rise or take a second job – or, more likely, work out where you can cut your expenses.
If, on the other hand you are lucky enough to earn more than you spend, then a budget will pick up how much “spare” cash you have and tell you in a stroke how much extra you could be putting towards a pension or other savings every month.
Budget planning: how to do it
If your finances are like mine, working out your total monthly income is pretty easy. There’s a salary and some investment income. However don’t forget to note down anything else that’s relevant such as maintenance payments and tax credits. Checking the credit column on your bank statement may help with this.
Now for the harder part – tracking monthly expenses. You need to record everything you spend in one place, perhaps a diary or notebook – and I mean everything! Not just the obvious stuff such as mortgage payments, gas bills and so on but also all those coffees, croissants, newspapers and haircuts. So either divide your notebook into columns with appropriate headings – the more the better – or consider using a preprepared spreadsheet – see an example here.
Keeping this record up to date isn’t easy, especially if you use a mixture of cash and credit cards, so try and get into the habit of keeping receipts and updating your diary or spreadsheet every day. Also when you are drawing up the headings consider making a clear distinction between discretionary expenditure such as meals out, alcohol and trips, and the stuff you can’t avoid such as utilities, council tax and the mortgage payment. Lastly, you may have to estimate some items each month if say your gas bill only comes in every quarter. That’s fine – make an estimate by dividing the last quarter’s bill by three or to eliminate seasonal fluctuations, the last year’s bill by twelve, not forgetting to add a bit for this year’s price rises! Remember the aim is to capture and record most of your expenses, as accurately as possible.
Budget planning: how to use it
Once you have a reasonably accurate summary of where your money comes from each month, where it disappears to and the size of the overall shortfall – it may take two of three months of practice to build up the picture – you can start to identify where you can make savings.
First off, get control over your fixed costs, the ones that just can’t be avoided if you run a house (utilities, mortgage repayments) and a car (insurance and servicing). How? My grandparents, who were wonderfully frugal, always used to keep a series of envelopes on top of the fridge containing cash set aside to pay essentials such as that month’s gas, electricity, phone and basic grocery bills. If the envelope ended up empty before the end of the month, they knew exactly where any extra money was being spent and could adapt by either upping the budget or perhaps using the phone less often. Simple but effective.
Alternatively consider setting up a separate bank account called say “house account” into which a fixed amount of your salary is debited each month to cover essential bills. That way you know exactly what you are spending on “needs”. Don’t forget savings either – that rainy day fund of three-six months salary is a “need” in tough times so earmark a regular amount that goes to a separate “best buy” Isa savings account too (see moneyfacts.co.uk).
Now for non-essential “wants”. Cutting back on these isn’t easy but for some it’s vital to balance the budget. For example I spend nearly £200 per month just buying my lunchtime sandwich and coffees from Prêt-a-manger. However I could just as easily make my own sandwiches and use the kettle twenty feet away from my desk more often and save most of that £200 in the process. I have a choice.
More significantly, many people don’t fully realise quite how much they are spending each month on clothes, meals out, DVDs, and a big one, holidays, simply because everything goes onto a credit card and is forgotten about as soon as it is paid for. There is always scope to economise here and start boosting those savings but only an accurate budget will reveal quite how much money is being frittered away.
Budget planning: the bottom line
Yes I admit it, budgeting isn’t exactly exciting but the feeling of control it gives you is, well, almost exhilarating if you are a first-timer. You also get to find out exactly who is fleecing you once you know how much is disappearing each month on insurance, or gas bills or maybe bank charges. That should spur you to shop around with the help of sites such as uswitch.com or moneysupermarket.com. Only proper budgeting will reveal how much your “lifestyle choices” are really costing you and with a recession looming, now is a great time to make some cheaper ones.
Finally, if debt repayments are starting to overwhelm your budget, The National Debtline offers free and confidential advice on 0808 808 4000.
Merryn Somerset Webb is away.
This article is taken from Merryn Somerset Webb’s free weekly personal finance email, Money Sense. Click here to sign up now: Money Sense