Managing money may not have been one of our worries in the early stages of our life and thus, we may have developed some habits which may not be well suited to the current times and needs. So the question comes, what habits can we develop now to take better control of our money. Here are a few habits one can focus on:
1. Budgeting
2. Prioritize Spending
3. Using Debt Wisely
4. Pay Yourself
[1] Budgeting:
Budgeting starts with most basic steps of managing money, and goes to an advance level of allocation of money for various goals. It includes following steps:
A. Recording Expenses
B. Classification of Expenses
C. Setting Limits
A) Recording Expenses:
So, we start with the most basic steps of accounting for our expenses. If you have been spending without recording your transactions, first step is to record your outflows and inflows every day. This exercise may seem tedious in the beginning but, going forward this will become the most
useful and effective tool towards the total control of your money. Once you have your expenses recorded at one place move to the second step of clubbing your expenses under various heads.
B) Classifying Your Expenses:
Purpose of various expenses can be similar and different. We can classify all of them based on their importance in our lives or based on our own obligation towards them. For example: We may not be able to postpone home loan EMI payment but we can postpone the home theatre purchase to another month. Another way of classification (more popular one) can be by putting them under heads depending on the area of life they relate to. For example: Rent, home maintenance, kitchen expenses can be put under Household Expenses, similarly travelling and fuel expenses can be put under Commutation expenses to better understand the area of spending.
Major Expense Heads in an Individual Life are as under:
> Household Expenses
> Utilities Expenses (incl. electricity, water, phone, mobile etc.)
> Travelling/Commutation Expenses
> Lifestyle Expenses (incl. outings, weekend exp., dinner etc.)
> Education/Children Exp.
> Subscriptions
> Insurance & EMIs
> Other regular Out-flows
C) Setting Limits:
Different expenses have different value in our day to day life, for example: Money spent on commuting to office from home is a choice between taking a metro, auto, taxi or own car. Similarly some expense, do give us choices some do not. Going forward you’ll find that most expenses give you options, though, exercising these choices may be easy or difficult at times. Providing a limit to the expense head in the beginning of the month will give you sufficient motivation throughout the month to keep it within that limit.
[2] Prioritizing Spending:
Priority of expenses depends on the obligation or avoidable and unavoidable nature of expenses. Like we discussed above, some expenses can be postponed and some cannot be, will define the importance of that expense in your financial life. Likewise, EMIs, Insurance Premiums, Children’s School fee etc. have priority over, weekend dinners and outings, but kitchen expenses are even more important.
[3] Using Debt Wisely
Use of debt is almost common in today’s lifestyle to provide for various expenses and investments. Problem with the
Debt comes in two forms:
A. It can make things expensive
B. Creates a long term obligation
Use of debt can be tricky as you’d not like to take a long term obligation for purchasing something which will depreciate over time, for example: Purchasing expensive electronic items on EMIs. With such purchases you will quickly find that the obligation of paying EMIs for long period is a toll on your savings and may create more dissatisfaction than satisfaction from material ownership.
When and How to Use Debt?
Most intelligent place to use debt is to purchase assets that:
> May increase in value over time,
> Give you tax breaks and
> Are too expensive to be paid for in one go.
Best example for the same is real estate. But this will also mean that you can make certain investments which are riskier than a deposit but have the potential to return more than the interest paid on borrowed money. But investing by borrowing is an advanced concept and not recommended for people with weak cash inflows.
How to avoid use of Debt?
The best way is to plan in advance. Though, it’ll be difficult to avoid use of debt in all possible purchases, but planning in advance will allow you to not only avoid huge amount of debt, but will also allow you to purchase something better. Also for purchase of assets which are going to depreciate early planning will ultimately save money as well, as you can earn interest on the savings you do towards it
[4] Pay Yourself
This is a method which gives you a definite amount of money regardless of total inflow, and even when you are trying really hard to save more and more money, paying yourself first will enable you to be satisfied even with major cuts in expenses. This is what you need at a bare minimum to enjoy life as it is and not just live it for money.
The Amount you pay yourself will depend on couple of things like:
> Your Personal Expenses
> Expenses for activities to de-stress you
These are generally the expenses that keep you going and help you achieve satisfaction from your day to day life. For example: when you go to your business or office, you cannot just roam around with an empty pocket, some or the other petty expense, where it’s about an occasional coffee with colleagues or fare
for an urgent commute you will need some money which cannot be planned.
Improving Outflow to Inflow Ratio
This is the ultimate objective of whole budgeting exercise. You would want to improve your savings ratio to meet your future demands. Since, we are focusing on good financial habits, budgeting counts as the most basic and most important one. All habits and their consequential purposes as discussed above can be summarized as follows:
1. Plan in advance
2. Budget your expenses
3. Prioritize Your Expenses
4. Avoid Debt for small expenses
5. Pay Yourself
Any kind of habit takes time to sink in and become a part of your conscience. Financial habits are no different, what is required is practice and if you sincerely practice, within no time you will be living them as per your convenience. Good thing is, small concessions now grow into huge benefits later, and this is what good financial habits are all about.
As can be seen from the above graph just to maintain the same standard of living for a family with monthly expense of .25000 one would require 1 lakh per month after 20 years. Again this is just with an assumed inflation of 7%.
