Small changes in how we plan our monthly budget can make a huge difference to our long-term financial health, and ultimately can give us the financial freedom to live the life we want. In this article, we’ll talk through getting to grips with your current income and spending and how to build a successful budget.
1. Working Out Your After-Tax Income
The first step to planning a healthy budget is to work out how much income you have coming in each month after taxes and mandatory contributions. This differs quite a bit from country-to-country with some having automated deductions from their pay for items like student loan repayments, health insurance or pension payments. Try to reach a conservative estimate of how much you can expect to receive into your bank account each month. You can then break down each of the following spending categories as a percentage of your take-home pay.
2. Rent and Mortgages
For many of us, accommodation is the greatest ongoing expense, eating up a significant percentage of our income. Data from 2015 showed that European tenants spend an average of 28% of their income on rent, with renters in the UK and Spain paying 39% on average. For those who rent, choosing a less expensive flat or sharing with others is a short-term sacrifice for longer term gain. For those who are paying down a mortgage loan on their house, shopping around for lower interest rate deals where available is often worth the hassle.
3. Debt Repayments
Sometimes when you’re struggling with debt it feels easier not to think about it. However, to budget effectively it’s essential to understand the terms of any outstanding debts, their interest rates and the amount to be repaid. Focus on repaying the highest interest rates first and save aggressively until you are on top of your repayments.
4. Monitor Monthly Outgoings
It’s relatively straightforward to predict your accommodation payments and longer term debt obligations. However, to understand how much you spend on household bills, food, transport and discretionary spending you’ll have to do more research. One method is to keep a note of spending on your phone or on paper. If you tend to pay for everything by card rather than cash, another method is to export data from online banking and try to piece together what each payment was for in an Excel spreadsheet. There are even some apps which aim to help you with this too, some pull in read-only data from your bank and try to automatically monitor your spending patterns for you.
Aside from apps, there are a few professional tools you can use to help you budget. Microsoft Excel is an old favorite but can be a lot of manual work. Instead, you can try dedicated online tools like YNAB (You Need A Budget, etc.).
5. Optimize Spending and Invest
By this stage, you should have a good idea of your expected monthly income and a breakdown of ongoing spending. You can look into the data to try to spot ways to save money and cut out unnecessary or frivolous spending. You can then use some of the excess income each month to save and invest. A sensible investment portfolio will give you an ongoing income alongside your job.
Personally, I think of each investment as a potential ongoing income for the rest of my life. As a basic example, you could either buy a new TV for €500 or make do with what you have and invest the money. Theoretically, if you were to invest that €500 with a 6% return it could pay you a return of €2.50 a month for the rest of your life whilst maintaining the initial capital. With a 12% return, similar to the rates seen on VIAINVEST, it would potentially give you an ongoing income of €5 per month. When you apply this to many different spending decisions it all adds up in the long term and can become a substantial source of income.
6. Extreme Budgeting
In recent years some people have taken budgeting to the extreme with concepts like ‘FIRE’ (financial independence, retire early) made popular through blogs like Mr. Money Moustache and The Mad Fientist. The premise of FIRE is to cut out unnecessary spending, save aggressively and invest wisely until your investment income covers your spending and you are financially free.