Finance: Budget It or Not !!! (Part 1)
This is a 2 part series where I will answers questions such as What is a budget?, Why is a properly planned budget needed? in Part 1 and What is my strategy on personal budget planning? in Part 2
What is a budget?
According to Investopedia, ‘Budget is an estimation of revenue and expenses over a specified future period of time.’ We are very eager when the Union Budget was presented by our Honourable Finance Minister. Though the focus for us was more on ‘What is in it for me?’, the bigger picture what we received was the financial health of our country. The health of any country can be measured through various parameters such as spending across categories, fiscal deficit etc.,
Similarly, a personal budget is a helpful tool to reflect the financial health of an individual. Through a personal budget, the financial health of an individual can be accessed with the help of parameters. Without a proper planning of personal budget, an individual is more likely to fall into a debt trap similar to how a country might default in the absence of a proper budget planning.
Do we need a personal budget?
Before delving deeper, let us analyse on the need for a personal budget. Here are some of the reasons behind maintaining a personal budget:
i) Snapshot of income and expenses:
A properly maintained personal budget presents an exact snapshot of income and expenses of an individual. This snapshot can be used to assess the financial health of an individual.
The accuracy of the snapshot depends upon the discipline of an individual to record income and expenses or in other words ability of person in maintaining a proper personal budget.
ii) Keep the expenses under check:
Generally, the expenses fall under 2 major categories- needs and wants.
A need is an entity very much essential to live and function (eg: food, rent, transport etc.,)
A want is an entity which improves the quality of life and an individual can live even without satisfying the wants. (eg: eating out, discretionary and impulsive spending etc.,)
With a proper personal budget in place, an individual can take data driven decisions to spend less on the wants and critically analyse the needs. This idea doesn’t necessarily propagate the philosophy of living a monk life without any wants. Instead, this gives an individual a greater clarity on what their wants are and where exactly their money goes.
iii) To invest in goals:
When the spending on wants is kept under check, then the resulting saved money can be routed to short term and long term goals.
Please check the link for my article on Goal Based Financial Planning https://medium.com/@raghav-sk1611/why-is-goal-based-financial-planning-very-important-8474292c264e
A short term goal is one which must be achieved in 1–3 years and any goal whose timeline to achieve is more than 3 years can be classified as a long term goal. There can be separate trackers maintained individually for these goals.
iv) To estimate the insurance cover needed:
Many people consider insurance either as a tool merely for tax savings or as a retirement benefit instrument. While the former can be agreed to some extent, the latter is not true according to me. There are many other financial instruments such as stocks, mutual funds etc., which can handsomely beat inflation and help build a retirement corpus and not an insurance. Insurance is basically a tool which comes handy during emergency and crisis situations.
The million dollar question which everyone taking a term insurance have in their mind is ‘What is the sum insured I should look at?’. Since the term insurance acts as a replacement to the person insured, a good benchmark to decide would be monthly expenses with a multiple of inflation over a period of time. In this scenario, a properly planned personal budget helps to decide the value for monthly expenses. Now, multiply this with inflation and then you get the value for the insurance cover needed.
v) To decide on the emergency fund:
Emergency fund is a corpus that saves people during rainy days or emergency. According to various financial pundits, 6 months of monthly expenses has to set aside if there are 2 earning person in a family or 12 months of monthly expenses to be set aside if there is only 1 earning member in a family. Here, what is the exact amount to be saved for the rainy days can be decided through a properly planned personal budget.
In the next part of the series, let us explore the strategy on personal budget planning.
