Budgeting – the foundation of financial independence.
It’s generally been my experience that there seems to be a lot of people who hit their thirties and then start to wonder about this creature called “financial security”. They start to wonder about things like Mortgage and kids and unexpected financial events in their life and really start to think about how do I get financially comfortable when these events happen? A great many people live hand to mouth and live for the moment, rather than planning ahead and end up realizing when it is almost too late that they haven’t planned for their future.
Let me make this point clear. ANYONE can retire very comfortable. It doesn’t matter what your income level is, your level of education, whether you went to a private school or any other factors – all it takes to become financially independent is 1) Self Discipline and 2) A small amount of Knowledge.
The average Australian will earn approximately 1.8 million dollars during an average working life. For every Australian working today 8% will become “Financially Independent” when they retire. (we’ll talk about this definition in a second). Out of 100 people aged 15 today, by the age of 65
38 will be deceased
38 will be living in poverty
16 will still be working
7 will be retired on a livable income
and 1 will be wealthy.
The way that the ABS (Australian Bureau of Statistics) defines “Livable income”? – In retirement your income is 60% or greater of your last year’s pay. “Wealthy” is defined as your retirement income is greater than 80% of your last years pay. Yet with just a small amount of information and self discipline – those numbers could be MUCH better.
So with those scary numbers in front of you lets talk about budgeting, because budgeting really is the foundation upon which you will build your financial security in the future.
Most people think that they know how to budget. My income is x my expenses are y, if I take y from x and end up with a positive number – I’m good. Unfortunately proper budgeting has a bit more to it than that. You should sit down with a full years worth of expenses in front of you and then classify these expenses as Vital, Necessary or Lifestyle expenses. You then take these expenses and work out how much that means from your periodic wage (Eg monthly, fortnightly, weekly).
Of course your expenses are not nice and neat and broken down into discrete periods that match your pay packet. You’ll tend to get periods that are expenses heavy when your car rego, rates notice, insurance bill etc etc all happen at once. These events need to be planned for by allocating funds towards them out of your periodic pay packet.
It’s as simple as creating a control account (which is what you ACTUALLY have as disposable income after you’ve paid ALL your expenses rather than what your current bank balance happens to be. If there are expenses that you can plan for, (EG you want to spend $500 on Christmas presents for the kids this year) – you allocate this an an expense in your control account, and work towards it slowly over time.
You’ll soon find that when you are aware of all your expenses, your ability to save money will be greatly enhanced. But here is where the self discipline I mentioned previously (and the little bit of knowledge) come in.
Self discipline – There’s money in the bank – damn that 52 inch plasma TV looks good doesn’t it? Or how about that day spa package in the Hinterlands eh? Oo can I pimp the car out with a tight car stereo system?
Knowledge – So we need to apply some self discipline and some rules to our disposable income. Ready? here we go…
Budgeting Golden Rule number 1
Pay yourself FIRST – For every dollar that you receive – you should put 10% aside for future investment. This should be classed as a VITAL expense in your budget.
Why? Because of the benefits of compounding and the advantages of leverage. If you know exactly what your expenses are and what your disposable income is (after rule 1), you can (subject to adequate security), through the advantages of leverage support a proportionally higher share portfolio. Every $1 dollar saved can be worth if properly and safely structured $4 each year and every year, year after year after year.
I’m not going to add the famous example of which you would rather receive. A million dollars today, or $1 doubled every day for a month. For those of you interested you can look it up, it basically shows you the power of leveraging and brings you to the important realization that compounding effects are greater over longer time frames.
Budgeting Golden Rule 2)
If you want it – plan for it – Don’t impulse buy and don’t go into debt for something that depreciates in value.
Pretty simple rule – amazing how often people don’t follow it. Keep rule 1 firmly in your head at all times and realize that every dollar saved is worth far more in the future.