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How To Make A Budget

Creating an effective budget is not only for the coupon clippers and penny pinchers.  Whether your monthly income is $3,000 per month or $30,000 per month, the same budgeting fundamentals apply, and can have a significant impact on your life.  Take the example where you are somewhere in the middle, and should easily be saving a sufficient amount of money each year, and while it certainly feels like you are saving each year, as the years go by it always seems like the cash level in your bank account stays the same.  Without proper money management, it is easy to lose track of where it all goes each month or each quarter, making it nearly impossible to remedy the issue of not being able to adequately save.  The first step is to understand your situation.

Start by laying out all major necessary expenses and then working your way through to the purchases of lesser importance.  Depending on your situation, the primary living expenses like rent and groceries could end up constituting a fair portion of your monthly expenditure.  Having a large family will of course push this number up as well.  For most of the regular big ticket payments each month you should already have a firm grasp of costs, but drilling down to the specifics will require more extensive expense tracking.

Since you have already made the conscious decision to sit down and hammer out a budget, it would be best to do it all properly in one go.  This means going through old bank statements and credit card statements. Thanks to readily accessible e-statements this should only require tracking down your online login details for each to then access the last 12 months’ worth of expenses.

Statements in hand, sit down and compile each regular monthly payment.  This includes utilizes, rent, mortgage, cell phones, internet, gym memberships, car payments, insurance, child care, student loans, etc.  The easiest method is to compile these monthly expenditures on an excel spreadsheet, allowing you then sort by type or priority. The amount of the expense may not be the same each month, in which case simply take an average approximation of the regular expenditure.

The next step is to track down all the irregular expenditures throughout the year. This includes big one-off purchases, such as residence or car tax, children’s school fees, vacations, charitable giving, etc.  This may require some digging and thinking, but you should be able to come up with a rough figure of total expenditure for the year on each of these major items.  Then, divide all the total figures by 12 to arrive at an approximate monthly average impact for these irregular but major expenses in your budget.

Combing through the bank statements to compile the bigger expenses above should also give you the opportunity to see inside your spending habits with regards to smaller ticket items like clothes shopping, dining out, gifts, or other entertainment.   Take some time to get an approximation for the average amount spent on these miscellaneous lifestyle purchases, and categorize them by type for an average amount each month.  You may find that the “small” purchases in fact add up rather quickly to a level of spending that is more than you had anticipated.

After working through the above exercise, you should have a firm grasp of your regular income and expenses.  Most people find that the primary culprits leading to an inability to save for the long term are the large irregular expenses, or a piling up of small purchases.  For example, while it may feel like you are saving $1,000 each month, if in the last 12 months you have had a big unplanned-for tax bill and took a couple vacations, it should be no mystery as to why there are no additional “savings” left in your savings account at the end of the year. Proper budgeting can help you account for and prepare for all expenses throughout the year, and then plan proper savings and investments on top of all that.

The 50/30/20 Rule

While we have written extensively in the past on how to invest and how to divide up your savings among short, medium, and long-term savings; this still begs the question of “how much should I be saving in the first place?”.  Of course, it would depend entirely on your financial position, your career projections, and family plan.  However, a good rule of thumb for how to divvy up both your savings and your spending is the 50/30/20 Rule.  For example, in the above budgeting exercise, you may have noticed how the first step in clarifying your spending habits is to divide spending into necessary items like rent and groceries, and then more lifestyle spending like entertainment and vacations.  This categorizing of expenses is key in that it enables you to then set targets for each category.

A healthy and sustainable barometer for your own month to month financial planning would be to stick to a budget whereby 50% of your income goes towards mandatory spending such as rent, food, healthcare, etc., and no more than 30% of your monthly budget devoted to lifestyle expenditures such as shopping, entertainment, or vacations. This still leaves a healthy 20% for savings, which is a good start for splitting up across different financial goals, such as long term retirement planning or a more medium-term education savings structure.  This calculation is, of course, done using your net income after tax, health, and social insurance deductions. Taking this net take-home monthly salary amount and splitting it up into categories the above categories can, at first, make it feel like you are earning less and, accordingly, have much less money to spend each month.  However, this is a key first step in managing your finances to live within your means, reign in wasteful spending, get the most value out of whatever money you do decide to spend, and then maximize your savings for the future.

That said, the 50/30/20 Rule is certainly not something to be set in stone.  For example, if you are just getting started in your career or have a large family, it could be difficult to find room in the budget for extensive lifestyle spending.  On the other hand, those on the higher end of the earning spectrum could find difficulty coming up an excuse not to save 50% or more of their income.  Sitting down with an experience professional to go over your current or planned budget would be a chance to receive guidance on what sort of strategies do or do not work, and what sort of trends your peers may or may not be experiencing success with.

There is no shortage of budgeting software available on the internet or through mobile app stores, some being free while others are for a small purchase price. The more successful and popular apps (in Japan also) are able to log in directly with online bank accounts or credit card accounts to track and categorize spending for you.  However, perhaps due to security reasons and a not yet fully developed online banking system ubiquitous throughout the country, most of the popular budget apps from elsewhere in the world are not able to directly connect to Japanese domestic bank accounts.  Accordingly, for the time being the above calculations and budgeting plan would need to be done manually, or with a professional advisor.  However, most people find that the act of sitting down and working through the paperwork and calculations leads to a better understanding of their financial situation as well as a stronger appreciation for any budget or savings plans they are in turn able to set up.

 

[Sources]

-Is there a budget fallacy? The role of savings goals in the prediction of personal spending, J Peetz, R Buehler – Personality and Social Psychology Bulletin, 2009

– Motivation and financial literacy, L Mandell, LS Klein – Financial services review, 2007

– Household financial management: The connection between knowledge and behavior, MA Hilgert, JM Hogarth, SG Beverly – Fed. Res. Bull., 2003

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