How to Budget Principle # 2
In this series of blogs I am looking at the 5 core principles that made my Grandma’s budgeting system so simple yet so powerful. While we no longer budget using a collection of glass jars tucked away in the kitchen cupboard, the principles behind Grandma’s system are just as relevant today as they were 25 years ago.
In the previous blog we covered the first principle of budgeting which was ‘Have a comprehensive understanding of your expenses’. This blog we are going to focus on the process of calculating how much we need to set aside for each expense on a monthly basis.
At the start of each year having reviewed all her expenses, Grandma would sit down and calculate exactly how much she needed to put into each jar every pay day to ensure she had exactly the right amount to pay the expense when it turned up. She would then change the label on the Jar to reflect the new amount she needed to put into it each pay.
As I highlighted in my last blog life was a lot less complicated in Grandma’s day; she only had 5 jars to worry about. My experience is that most people today will have somewhere between 10 – 20 jars depending on their stage of life. The budget worksheets that I give to clients have 19 different expense categories (jars), however very few people have quite that many. If in doubt, less is always better.
Despite the fact that our lives are more complex, do not let this put you off. You may have 20 Jars as opposed to Grandma’s 5, but the principles remain exactly the same.
Having produced a comprehensive list of your expenses and an annual dollar value for each expense (Principle 1,) you then need to calculate how much you should set aside each week, fortnight, or month to ensure that when that expense turns up you have enough to cover that expense.
My Grandma calculated how much she needed to put aside fortnightly. However, based on 15 years of experience as a budget coach, I have learnt that budgeting to a monthly cycle is far easier.
I can fully understand people’s tendency to want to budget to their pay cycle, so if you get paid fortnightly you want to budget fortnightly, however here are three reasons why I strongly recommend that you budget to a monthly cycle:
Most bills are multiples of months.
While you can opt to pay some bills weekly or fortnightly, the default bill cycle is always monthly – and that because it is easier for everyone to administer.
Budgeting monthly helps break the pay cheque to pay cheque cycle.
Most people get paid weekly or fortnightly, so when you budget to your pay cycle it is very easy to get caught in the pay cheque to pay cheque cycle. Budgeting monthly helps you see beyond the next pay day. Once your budget is up and going it will not matter what day you get paid, there will always be enough money to cover the bills, fun stuff and day-to-day living costs.
It is far easier to reconcile your budget with your bank accounts on a monthly rather than fortnightly or weekly basis. An essential part of a successful budget is to be able to reconcile your budget with your bank account; after all there is no point having a budget that says you have $100 to spend at the grocery store if your bank account is running on empty. This reconciliation process is best done to line up with the end of each month. It takes the same amount of time regardless of whether you do it weekly, fortnightly or monthly so my preference is to do it just 12 times a year rather than 26 or 52.
Okay, so what we need to do now is convert every expense to a monthly figure. Do not worry about when the expense is paid, all we are trying to figure out now is how much do we need to put into the jar each month ie 1/12th of the annual amount.
The maths of converting every expense and your income to a monthly figure is a simple two-step process.
Using the above formula you should be able to identify exactly how much you need to set aside each month so that when each bill and expense arrives you have the funds to cover it.
So if I use the example of my weekly rent, if my rent costs $300 per week, the calculation would be:
Now I know I need to allocate $1300 each month to my utilities jar to cover my rent.
Having now converted all your expenses to a monthly figure can you see a flaw in this budget system, if you are starting a fresh budget today.
If I start putting 1/12th of my expenses into my jar each month starting this month, what will happen if an annual expense I am saving towards (such as my car registration) turns up in 6 months’ time? Yep, you got it – I am going to find myself 6 months’ short of the amount I need to pay my car registration and probably decide that budgeting simply doesn’t work.
At Grandma’s Jars, we call this the budget shortfall. Everyone has a budget shortfall when they first start a budget and you will be no different. This budget shortfall is one of the major reasons most people fail at budgeting. In the next blog we are going to look at how to identify your shortfall and how to deal with it once you have found it.
But for now, let’s summarise Principle 2 of ‘How to Budget like Grandma’ – Once you have identified all your expenses and have an annual dollar figure against each expense (Principle #1) you need to convert this to a consistent amount that you can put aside into your jars at regular intervals.
While you can make this a weekly or fortnightly figure my recommendation is that you work to a monthly cycle. It might take a little more work initially but you will quickly discover the benefits.
As outlined above our next blog will focus on how to identify your budget shortfall and how to deal with it once you have found it.
As always if you have any questions please don’t hesitate to leave us a question below.