How to plan a budget in percentages
Deciding on the portion of income you want to spend under various heads in advance helps you stay within budget
A budget is probably the least favourite of must-dos for a person trying to get a grip on her personal finance situation. The discipline of tracking expenses, assigning an amount for each and then staying within the allocated budget can all be a put-off. However, one has to start somewhere. “The ideal point to start is to make a distinction between discretionary and non-discretionary expenses and see how much you are spending on things,” said Manish Shah, co-founder and chief executive officer, BigDecisions.com, a financial advisory.
A simple method to make sure you are on the right track if you are just a beginner is to work with percentages. It will help you identify where you are overspending. Here is how you can do so and how much you should allocate to each expense.
Limit each expense
First of all, limit each head of expense to a range. This will help you stay within your income and take care of saving priority. “Work with your take-home pay so that you don’t exceed what’s available. At the same time, consider any allowance, such as for accommodation or travel. Write down all expenses for three months and then review. Care should be taken to reduce unwanted items in future. Based on this, one can prepare a budget,” said Melvin Joseph, founder and chief financial planner, Finvin Financial Planners.
Here are some percentages that can be used as pointers. Use the percentages as guides, but custom tailor the budget.
Savings—15% onwards: The first goal for your savings should be to create an emergency fund. “There are three basic types of emergencies—loss of life, medical and job loss or potential loss in business. Be adequately insured for all three,” said Shah.
For medical emergencies, financial planners advise on contingency funds for 3-9 months’ expenses. Also, have adequate medical insurance apart from what is provided by your employer.
“Try and start saving as early as possible in life. In fact, the sooner you start, the easier it will become for you to inculcate it as a habit,” said Shilpi Johri, head-financial planning, Arthashastra Consulting, a Gurgaon-based financial advisory. Have an investment plan in place so that your savings will work towards meeting various financial goals.
“It’s important to work on limiting your expenses as a family. In a single-income family, one member can curb the other’s expenses. Children, too, should be involved in activities, such as, saving electricity,” said Prakash Praharaj, founder, Max Secure Financial Planners, adding that these small contributions make the family aware of expenses.
Housing—25-33%: Housing is a major expense to be met out of one’s available income. It may be in the form of rent or equated monthly instalment (EMI) on a home loan. Include any mortgage insurance, taxes and other mandatory dues on the property in this amount. Exceeding one-third of your income, especially in the form of a loan, is risky to financial stability since it will restrict your ability to spend or even take loans for other needs.
Food—15-25%: Along with housing, this constitutes the biggest expense of a household, especially when income is low. This includes eating out, and if you find yourself exceeding the allotted limits, this may be the cause. “Keeping an eye on how many times you eat out, which is a discretionary expense, can be a good way to regulate your budget because you can eat out at a place for Rs.500 or for Rs.10,000. Try and regulate the number of times you go out so that you can use the amount you save under this head to fund other contingencies,” said Johri.
Utilities—10-15%: This includes electricity, water, communication, cable and other expenses. This is an area where you can exercise some control. Shop around for good deals that meet your needs, and don’t pay for facilities you will not use. Judicious use of electrical appliances, a more cost-efficient mobile phone package, and choosing only that bouquet of TV channels that you watch regularly are some ways to keep expenses low.
Transport—10-15%: The cost of commuting includes fuel charges, any auto loan repayment, and auto insurance. This is again a category that allows you to economise depending upon your income. For example, if the commute is long and you don’t use public transport, then you may want to consider a vehicle that is fuel efficient to keep your costs down.
Child’s education—6-10%: You would like to give the best you can for your children. Apart from the school fees and related expenses, you will also have to consider the cost associated with extra activities that children are typically engaged in. Try to save for these in advance. Ask about refund policy so that if the child leaves the programme for whatever reason, you are able to get at least some money back.
Consumables—10-15%: All the things that you use for maintaining a home and yourself come under this head. Again, this is a category that allows you to economise—buy things in bulk and cut out those that you don’t really need.
Apart from consumables, clothes, shoes and other such purchases need planning, so that you get what you want within your budget. “When we start earning, we tend to splurge with the cash in hand on things we might not need. So, instead of buying those three shirts together and making your wardrobe unnecessarily too big, try and buy what you need and use the rest of the money on other things,” said Johri.
Entertainment—2.5-5%: The thought of living by a budget but not being able to do the things that you like is a sure-fire recipe to make a budget fail. Set aside money to do the things that you enjoy, but without encroaching on money for other things.
Miscellaneous—1.5-5%: Unexpected expenses, such as repairs to equipment or vehicle repair costs, which are not covered by insurance, may catch you short of funds unless you have provided for it.
Be ready for give and take between the categories. If you live with your parents or your own house and are done with your EMI payments, you have the entire housing allocation for any of the other categories. Make sure you use it wisely for paying off debt or for investments and not only for upgrading your car and increasing your entertainment budget. Or, you may choose to live closer to your work place or children’s school and pay a higher rent in lieu of lower travel cost.
Remember, you have only your income to allocate to your expenses. If you live at 110% of your income, you are obviously setting yourself up for a debt crisis sooner or later. You can fine tune the budget over time with experience.
“Mandatory expenses cannot be avoided. Budgeting helps you differentiate between what’s essential and what’s avoidable. At the end, it will help in reducing the overall expenses and allot more money towards essential expenses,” said Joseph.
It is, therefore, necessary that the mandatory or fixed payments are not a very high proportion of your income. Limit loan and other debt repayments to not more than 40% of income. Doing so will help you manage obligations even if there is a reduction in income.
The need to cut back may also become necessary by a change to a lower paying job or a double-income family becoming a single-income one. “A double-income family should keep six months’ living expenses in a emergency fund and single-income family should keep it at nine months. This needs to be created before starting investments,” said Joseph.
If you see that your spending is exceeding the outer limit of your budget, don’t brush it aside as an aberration. Instead, question it and find the reason. This way, you are more likely to be able to control it.