Learning to budget is like learning to ride a bike. Uphill. Over a road with potholes the size of Thailand, while juggling three eggs and trying to recall the words to Bohemian Rhapsody. And if you fall, someone beats you over the head and takes your wallet. It’s frustrating and hard, is what I’m getting at. And the only thing worse than a budget you can’t follow, is a budget that’d cost you money. So make sure your spot these errors in your financial planner:
Before We Begin…Budgeting vs. Frugality
First, a quick note on budgeting vs. frugality. The two are related, but not the same.
Frugality is the end goal of budgeting. The budget is just a road map to getting there, nothing more. Having one doesn’t mean you’re already being frugal, any more than having a map to Jurong means you’re already there.
And as with road maps, a bad one gets you lost. It doesn’t matter how well you follow a budget if it’s inherently flawed. So make sure to avoid the following:
- Budgets That Ignore Opportunity Cost
- Budgets That Ignore Spending Cycles
- Budgets Not Based on True Income
- Budgets With No Investment Component
- 100% Efficient Budgets
1. Budgets That Ignore Opportunity Cost
A badly designed budget causes you to behave in counterproductive (and expensive) ways. A simplified example:
Say I’m a salesman, and I make $50 commission on every sale. It takes about an hour to make one sale.
But being a salesman, I also have to entertain clients. I take them to fast food outlets, cafes, etc., and I have a strict budget: Maximum of $10 per meal. So I draw up a list of places that match my budget, and always take clients there.
Now, what happens if I find a cafe that’s more conveniently located, but too expensive (say $15 per meal)? It’s above budget. But if I were to save an hour in travel time, that’s potentially another $50. The benefit would outweigh the cost.
Here’s another example:
Say I run a blogshop, and I budget $50 a month for a super-cheap web developer. Great, I save a ton of money. But then sales plummet, because anyone seeing the site’s too busy wiping their vomit off the keyboard to browse. Over the span of a few months, the budget might save me hundreds…and cost me thousands.
So consider what a budget plan would cost you, not just what it’d potentially save.
2. Budgets That Ignore Spending Cycles
Some people budget by taking their monthly income, and then dividing it by 30 or 31 days. Or maybe they divide it by four weeks. Which would work, if anyone actually spent money that way.
In reality, most people have highly individual spending cycles. That is, specific months or years when their spending intensifies. Ever since I became an editor, for example, my budget plan has had to vary every third month (When I buy all my hypertension pills).
Another thing to watch for are annual or semi-annual surges in spending. These tend to happen due to events like Christmas, New Year, gym or club memberships with annual payments, etc.
The danger here is an unexpected “lump sum” bill, which shows up unplanned. If you’re on a tight personal budget (e.g. debt recovery), you might end up resorting to credit.
So plan a little further ahead with your budget. Track your expenditures over a year, and identify your own spending cycle. For more on how to do this, follow us on Facebook, or drop us an e-mail.
3. Budgets Not Based on True Income
Never build a budget on assumptions of year-end bonuses, total commissions, or anything equally variable.
The assumed income should be your base, fixed salary. If you earn on commissions, plan as if you’d make 20% to 30% less than you usually do. This is especially true if it the budget’s for a start-up, or if it’s to support a major purchase (e.g. renovation loan, education loan, insurance policy).
When you overestimate your income, the resulting budget plan makes some pricey things look affordable. You don’t want to buy an insurance policy, realize later you can’t afford it, and forfeit the payout.
4. Budgets With No Investment Component
Any budget plan, even a bad one, can create the illusion of financial security. Now I’m not saying budgeting is useless; just that improper budgeting can give you all the wrong ideas.
For example: If your budget plan leaves you with nothing more than emergency savings every month, you’re not far removed from people who live paycheck-to-paycheck. You just get to have the smug feeling that you are.
Proper budgets include an investment component; a way you can dedicate a sizeable enough portion of your income (at least 20%) to things like ETFs, REITs, etc. Otherwise, you might end up following a disciplined budget, which leads to stagnant savings and nothing to show.
Don’t let your budget cost you money in the long term.
5. 100% Efficient Budgets
100% efficiency means no waste, and no surplus. This is what happens when you allocate every last cent of a budget.
Then some sort of unexpected cost crops up, and what happens? If you’re lucky, there’s something else you can take out of the budget (which still means the budget failed). Otherwise, the money has already been committed to other things. You’re left with using credit, and incurring debt.
So when planning the budget, leave some allowance. Have at least 10% of the monthly income floating around in savings, to cover the unexpected.
edenpictures, saeru, Pekka Tamminen, Comrade Foot, the other Martin Taylor
Has your budget ever cost you money? Comment and let us know!
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