Co-authored by Smriti Bansal
When Michael was preparing for his MBA entrance exam, he got a freelance writing project for a fashion website. He was delighted to enter the new world of financial independence. His first income was a small amount of ₹2000, but it filled him with joy like never before.
The stage in our lives when we are starting to become financially independent is no doubt an exciting one. But along with it comes a huge dilemma: how much to spend and how much to save from one’s income.
We of course aim to fulfil our basic responsibilities with our income, but also dream of owning a fancy car, living in a big house, or buying the latest and best gadgets. We may also be aware that it is important to cover our risks through insurances and investments. But unless we plan our finances, time may fly by and we may not have anything to show for all the hard work we put in, in terms of our financial standing.
There is a continuous conflict between chasing our desires, fulfiling our responsibilities, and creating financial security for our future.
Hence, in order to secure our present and future, and to achieve our life goals successfully, we need to hone personal finance skills. One of the foundational skills of personal finance is budgeting.
So, what is budgeting?
Budgeting is the process of creating a plan of one’s expenses in order to keep track of the inflow and outflow of money.
You can compare budgeting to a full-body X-ray in which you can see which part of the body is malfunctioning. Looking at actual bills can give a clear idea of your spending patterns which can become the basis for budgeting. This may mean relooking at your spending patterns and trying to cultivate healthier spending habits.
Budgets can be both long-term and short-term, depending on the goals and desires of the person. Preparing a short-term monthly budget should become a regular ritual after getting employed. The inability to plan and budget can prove to be catastrophic for both your near and long-term future.
Why do you need to learn how to budget?
“What you want and what you need aren’t always the same. Be willing to delay short term GRATIFICATION for long term GREATNESS.” — Mandy Hale
The 21st century is all about consumerism. It’s not surprising that India’s household debt has increased from 8.5% of the GDP in 2012 to around 13.5% in 2018. We all want to have the best gadgets, wear trendy clothes, and celebrate at the most expensive hostels.
Social media and advertising constantly feed us with images of picture-perfect lifestyles, with all possible material possessions and experiences. But everything comes at a price. In the race to fulfil our wishes, we may end up burning all the cash in our wallets. And even then if we remain unsatisfied, we could end up taking loans and paying huge EMIs.
Budgeting can help us avoid this trap. Keeping a track of our expenses and savings can help us achieve our life goals without the additional burden of debt. When we track our expenses we become more aware of our spending patterns.
This can help us change our habits, relook at our priorities, and even actively work towards certain financial goals which are in alignment with our larger life goals. Basically, when we know where our money is going, we are more in control of where we want it to go and where not.
Budgeting is a tool which inculcates self-discipline in an individual which is perhaps the most important virtue when handling finances.
The reality is that every phase of life is important and making reserves for the future will help you live with grace in your 40s or 50s. It’s all about balancing income and expenditure and creating pathways for the success of one’s financial destiny.
A case study to understand the need for budgeting
Two friends, Tia and Maya, have finished college and got great jobs with salaries of ₹40,000 each.
Tia is a planner. Even when she was in college she would track her expenses and budget the money she was sent from home. So once she started earning, budgeting came naturally to her. Look at Tia’s neat monthly budget below.
Maya, on the other hand, is a carefree person. She never spent her time on things like budgeting when in college. She’s really excited about starting with work-life and earning. She also intended to save money but didn’t want to plan for it.
Maya doesn’t like boundaries and limitations while spending. In the last couple of months, Maya has usually ended up spending her entire salary or saving a meagre amount of ₹2000 to 3000.
Now picture this: after three years of working, Maya has been able to save ₹70,000 with minimal interest. On the other hand, Tia has planned everything meticulously. Her bank account shows a whopping sum of ₹4,32,000 along with an interest of around ₹50,000 which is the bright cherry on the cake. Look at the graph below to understand their expenditure and saving patterns.
They both had the options of spending their money in an unplanned and impulsive manner or planning their expenses by making a budget. We all have these two choices as well.
Needs vs. wants
Creating a monthly budget and allocating finances to various expenditures is not an easy task. We all invariably have to choose what we spend our money on. This is the needs vs. wants dilemma which everyone faces. We mentioned ‘healthier spending habits’ earlier in the article. Distinguishing between needs and wants is the basis of healthy spending habits.
Needs are the necessities that are essential for our survival. Wants, on the other hand, are our desires that we want to fulfil for our comfort and pleasure. Let’s look at a few examples.
- Buying a car to move easily and affordably from one place to another is a need, but buying a Kia Seltos, a high-end SUV, is a want.
- Buying monthly groceries for cooking food at home is a basic need, but going to restaurants or ordering in regularly, is a want.
You might wonder then whether or not fulfilling our wants should be a goal. Well, instead of chasing just our desires or only our needs, our goal should be to bring a balance between the two. This can be effectively done by prioritizing.
Below is a simple matrix that you can use to prioritize your expenses.
1. If something is both a need and a want: pursue it immediately.
2. If something is only a need: recognize it and take action.
3. If something is only a want: delay it and revisit it after a few months.
We need an extremely clear vision to identify and differentiate between our needs and wants. Confusing wants as needs can be dangerous in the long run. We may need to be strict with ourselves, but this kind of self-discipline can also feel rewarding once we realize that it is for our own financial security and growth.
Is budgeting necessary?
We all used to write with pencils in our childhood. Each time the pencil lead used to become blunt or break, we had to sharpen it. It was not only difficult writing with a blunt or broken pencil, but our handwriting and the clarity would also suffer, right?
The point is that we are only as good as the tools we have. We may have the best ideas, but we need the right tools to craft them into reality. Learning the skill of budgeting is similar to sharpening a pencil or an axe.
Budgeting is a basic prerequisite in order to successfully manage our finances.
Hence, the magnitude of your success in handling your personal finances lies in how effectively you execute this foundational skill of budgeting.
Budgeting, though a very crucial personal finance tool, is often underestimated by younger people. We often overlook its importance and blindly jump on to other advanced skills, such as investing, without laying the foundation. (Read our article on the Multiple Skills Involved in Personal Finance to know more.)
No building can stand tall in the long run with a weak foundation. If personal finance skills can be broken down into steps, then budgeting would probably be step 1 of managing personal finances. And as they say, ‘Well begun is half done.’