Budgeting is an important exercise if you want to keep your money in check. Budgeting your expenses allows you to control the outflow of money and spend where it creates more value for you.
Similarly, budgeting will allow you to stay organised with long-term plans as well. However, you might ask whether you can budget for your goals without a full-scale financial plan. So, here’s a step by step process to budget your goals and understand the essentials of financial planning even when you don’t have a full financial plan.
Before you Start Budgeting
The first step of any financial plan is to prepare you for life’s contingencies. Contingencies are unpredictable events that can set you back financially unless you are prepared with the right tools to face them.
For example, job loss, business slowdown, sudden hospitalization, accidents, disability, illness, or the ultimate hazard of untimely death.
Some of these events can be covered with insurance. For example, health insurance plans can help you financially in case of hospitalization and illnesses. Life insurance plans like term insurance will provide financial support to your family in case of your early demise.
Insurance, however, cannot help you cover the other financial hazards like job loss and market slowdowns. Thus, you need to build a pool of money to sustain your expenses during such times. This fund pool is called a contingency fund or emergency fund.
The ideal size of the fund would range from 3 – 12 months depending on your situation and trade.
Thus, before you start budgeting for your financial goals, you need to ensure the following:
- The premium for protection plans such as term life insurance and health insurance plans is automated for payment
- Building the emergency fund is the first goal (3-6 months’ income or 6 to 12 months of expenses). This fund pool must keep up with your rising income and expenses. Thus, contributions to this goal should be automatic as well.
Define your Financial Goals
Once you are all set to face any contingencies, you can relax and start thinking of achieving your long-term and short-term goals. While defining goals is very much alike despite the type and shape of it across the spectrum, real work is into prioritizing them.
You will need to use at least two parameters to prioritize your goals:
1. Time to Goal
2. Importance of achieving the goal for your family’s future
For example, buying a house and higher education for your child, both are important financial goals. But a child’s higher education goal could be 15 years away, while you would want to buy a house within five to 10 years.
Also, while defining the goal you need to be specific with the following:
- What is the goal about? i.e., Child’s education, new car, house renovation, etc.
- How far is the goal? i.e., 5 years, 10 years, 30 years.
- How much money you will need? i.e., your favourite car which costs Rs. 10 lakhs now may cost 12 lakhs five years later. So, you will need Rs 12 lakhs for the goal
- Can you extend the time? For example, you can postpone your car purchase goal by a few years, but not your child’s higher education goal
Other things you should remember while budgeting for your goals are:
- Long term goals may not change for a long time
- Short term goals will change frequently
- Budget for long-term goals first
- Many short-term goals can be postponed
Set a Savings Target
Once you have defined all your goals, you need to start saving and investing money to achieve them. Your total savings will account for everything from the contingency fund to retirement savings. The ideal ratio of spending vs savings should be 50:50. However, a higher savings ratio is always welcome.
While your contingency savings and insurance are towards a goal that you would not want to achieve, you may consider that as a necessary expense. Thus, your savings ratio for your short and long-term financial goals can be as low as 40%.
Meaning, if you are earning Rs 1 lakh a month, Rs 40,000 should go towards the following goals:
- Home renovation
- Child’s higher education
- Your retirement
- Car purchase
- Family vacation
Also, the 40% savings has to be divided for each important goal. Here are the best practices based on prevailing inflation and interest rates in India:
|Financial Goal||% Of Savings|
|Child’s higher education||10%|
|Child’s marriage||5 – 7%|
|Other Goals||8 – 10%|
The priority for allocating these saving amounts should be as follows:
- First to important long-term goals like retirement, child education etc.
- Second to less important long-term goals, like marriage, family vacation etc.
- Third to short-term important goals like home renovation, purchase, etc.
- Last to short-term lifestyle goals
5 Few Tips to Carry your Finances High all the Time
1. Always ensure timely allocation to term life insurance and health insurance policies.
2. Keep your contingency fund up to date with your present income and expenses.
3. Make lifestyle expenses less frequent and club minor lifestyle purchases. This will help you achieve better value for money in your lifestyle purchases.
4. Club similar lifestyle purchases for better value. This could mean postponing a few expenses and preponing others.
5. Use a credit card to prepone expenses only by a month but always with money in the bank account.
Hope these saving and budgeting tips will help you to attain prosperity and keep your family safe from unforeseen financial hazards. Remember, you need a financial plan so that you can prepare for the contingencies and sail smooth if something wrong happens.