Financial planners have a trick up their sleeve when it comes to re-focusing a client’s bad savings patterns, but we’ll share this with you here for free – ‘pay yourself first’.
It’s not actually a trick, but a different way of treating the ability to save. That is, to treat savings as a form of budgeted expense.
The thing to do is to transfer an amount of money, no matter how small, into a separate account where it can’t be touched. It can be a bank account with a higher interest, a managed fund’s savings plan, anything. The secret is to put this small amount away before you use it in another way.
A great proponent of the ‘pay yourself first’ method is our own government, which collects most of its personal income tax revenue in this way – using the PAYG withholding system (pay-as-you-go) as applied to salaries. In fact, because your employer retains a portion of your salary as tax and sends it to the government, you never even get a chance to spend it in the first place. The PAYG method is so efficient in garnering tax revenue for the government that the same theory is even applied to business tax revenue, with ‘PAYG instalment’ tax collection.
The theory is to put aside a little regularly, and try to put aside a little more whenever you can. Over time, money compounds. Over a long time, money can compound in a big way.
But to put the pay-yourself-first theory into practice, how much can you pay? The only way to know is to track down and record all of your income (from salary plus anything else) and all of your expenses (which will include all mandatory outgoings as well as discretionary spending).
Monitoring the lot may seem daunting. While you may be paid on a regular basis, and while also many expenses are regular and somewhat predictable, there are always unforeseen demands on your purse – birthdays, doctor and medicine bills, a flat tyre … and any of these can throw all your planning out of whack.
But this is where a good budget will come into its own.
Your budgeting goals don’t have to be big, and will be influenced by your situation, your age and family commitments, and the state of your other financial affairs (like whether you have debts to cover). And a budget will need to be fine-tuned over a year, as for example more heating over winter boosts that cost, or Christmas time may make you hit the credit card a little harder. And there are always those unforeseen items already mentioned.
Putting your budget regime into place can be as complicated or as simple as you want. There are some extremely sophisticated software packages out there if you have the skills, but even a straightforward Excel spreadsheet for your computer is enough.
Matching your pay period to the timeframe over which you plan your budget will make sense. So in recording likely expenses, do so either on a weekly or monthly basis, depending on your pay period. It may also be helpful to have a quarterly estimate as well, as some utilities bills are spread out over longer periods.
Once you’ve settled on a timeframe, estimate all the other amounts to match that period.
The first amount to record is your regular wages or salary, and possibly savings interest. Use after-tax figures if you can. If work is irregular and you don’t get the same amount each pay, try to estimate an amount close to what you would likely get if it were averaged out.
And don’t include one-off or uncertain amounts such as an annual bonus or hoped-for tax refund, because they just may not happen.
A lot of budget planning packages (see below) have sample categories for expenses, such as school fees, cable TV and so on, but these may not suit your personal situation. You will have to tailor your expenses to suit your own circumstances. But don’t forget things such as loan repayments, or credit card payments.
Also, don’t forget to set aside a little for savings (pay yourself first). Payments into savings should be categorised as an expense that needs to be covered.
Match expenses to your timeframe – for example, an expected quarterly bill of $400 can be budgeted as $33 every week. When the bill turns up, you will have made sure it is painlessly covered.
The difference, and fine tuning
Once you’re satisfied that income and expenses have been properly recorded, you will be able to clearly see where your money is being used, and to what end. After subtracting your total expenses from your total income, any adjustments that need to be made will become obvious.
It may be time to revisit estimated expenses, but if you are really spending more than you earn, then it will be time to look at what you can cut back on. But be aware that it could be a mistake to cut down completely to the bare essentials. Not only will that leave you exposed should one of the ‘unforeseen’ events crop up, you will miss out on having that ‘pay yourself first’ opportunity.
But if you do see a blow out for, say, a quarterly expense, then you would need to make a temporary adjustment in another area to get back on track. And at least once a year, revise your budget to see what other fine tunings can be made. Of course if you change jobs (or get a pay rise, fingers crossed), don’t be slow to re-do your income estimates.
Free budget planners
Many banks and fund management firms offer simple budget planning tools on their websites – you don’t really need anything too flash, just something that will help you identify what comes in and what goes out.
The Australian Securities and Investments Commission’s consumer website FIDO has a free budget planner that you may find useful. It is an interactive online calculator that will show you how your expenses stack up against your income, and you can make an adjustment to one area of your budget to see how that change will affect the end outcome. The government’s Understanding Money website also has an interactive Excel budget planner that you can access here.
If it is a credit card debt you are grappling with, try to make sure you pay at least the minimum each month to avoid further fees on top of what is already owed. And don’t be backward about looking for advice; for example the Australian Competition and Consumer Commission has some helpful suggestions about where to go for help with debt problems.
This story first appeared on www.taxpayersassociation.com.au