Here is the deal!
According to an article published by Yahoo Finance:
- household average unsecured debt in the UK has increased to slightly under £13,000 ($21,000);
- 1 in 20 families in the UK turn to payday loans to make ends meet.
To make matters worse, today The Independent reported that a study conducted by the Money Advice Service (MAS) found that over half of the adults in the UK struggle to pay their bills.
This is massive!
But the killer is that one in twenty people of the ones surveyed will still go for an evening out even though they can’t afford it!
One third of all Brits will go into debt to buy Christmas presents; yep, the ones people don’t need and mostly don’t like. And apparently these are the people who haven’t recovered from last year’s Christmas bills yet.
If you have the misfortune to be one of the people behind this statistics there is no space for panic. You only have to get a grip and take action.
I will make it easy for you by offering you the basics on three budgeting systems that work – we are a testament to that – and are easy to use and maintain.
Budgeting principles tested by time: The Richest Man in Babylon
You want something simple that has stood the test of time? The Richest Man in Babylon is just for you.
Written as a series of pamphlets on financial success, management and frugal living, The Richest Man in Babylon tells the story of Arkad: an indebted man who decides to change his financial fortunes and sets out to figure out the rules of money. Shortly before and during the Great Depression these pamphlets reached millions of Americans; today they have become a modern day classic.
Arkad figures out three timeless principles of money:
- Live upon less than you could earn;
- Seek advice from the ones who are competent through their experience; and
- Make gold work for you.
His budgeting rules are also simple and straight forward. If you have debt the budgeting rules are:
- Save and invest ten percent of all you earn;
- Use twenty percent of all you earn to pay debts; if the amount is insufficient negotiate with your creditors firmly and convince them that this all you can afford but you will pay diligently.
- Live on the seventy percent off your earnings that is left.
If you don’t have debt save and invest 30% and live on 70% of your earnings.
This should be doable except if you really earn very little and the basic costs of living can’t be covered by 70% of your income. In such case focus on increasing your income, and fast.
The Balanced Money Formula
The Balanced Money Formula was suggested by Elizabeth Warren and Amelia Tyagi in their book All Your Worth: The Ultimate Lifetime Money Plan . And the reason I like it is that it is not a budget.
The Balanced Money Formula is a guideline for achieving financial balance that allows you to live a life of abundance. It also ensure that you save towards your dreams and your future.
Warren and Tyagi’s Balanced Money Formula consists of three elements:
- Needs: this is everything that you absolutely have to pay and will include shelter, facilities, cars and insurance, food and basic clothing;
- Wants: everything above the basic needs that we have in our lives like eating out, going out, holidays etc. This category can include the things that you can cut out but this will cause temporary discomfort; and
- Savings: this includes also debt repayment till you are done with it (following the logic that debt repayment increases your net-worth just like savings do).
Three broad guidelines bring these in balance:
- You should spend no more than 50% of your net income on needs and ideally spending in this category should be kept under 35%.
- Up to 30% of your net income can be spent on wants.
- No less than 20% of your income should be put in savings.
Simple and doable! All you have to do is to know how much you earn and how much you spend, and what you spend on.
Budgeting The Money Principle way
When we first started managing our money and budgeting we experimented with the two approaches set out above.
They work but…
…we needed a system that allowed us to work out changes quickly and to reflect the changing nature of our budgets (and our lives).
We also wanted to create a budgeting tool (not a static budget) that allows us to follow our monthly income and spending, calculates our monthly cash flow (the difference between income and spends) and provides the detail necessary to manage our money efficiently and effectively.
For that purpose I came up with three different categories of spending:
- Constant expenditure: this includes all spending lines that don’t change very often.
- Changeable expenditure: includes all spending that can be negotiated at certain times like insurance, telephony etc.
- Variable expenditure: this includes food, drinks, clothes, entertainment etc. and is the part of your budget that is easiest to reduce fast. It is also the part of your budget that can easily expand and should be carefully watched.
The category that allows maximum flexibility is the ‘variable expenditure’; this is where quick wins can be had. However, the expenditure that can bring the maximum gain if lowered is the ‘constant expenditure’. In other words, this means that ultimately the winning strategy is to lower spending on shelter (rent or mortgage), electricity and heating bills, water bill and debt repayment.
The ratios between the different spending categories are likely to be different depending on where you are in the game of wealth.
Your main aim, though, is to increase your cash flow and direct it to savings and investments.
It’s your call! But the higher your cash flow, the faster you accumulate savings and capita’ for investing.
Currently, our proportions are:
- Constant expenditure: 31% of regular monthly income.
- Changeable expenditure: 3% of regular monthly income.
- Variable expenditure: 17% of regular monthly income.
- Positive cash flow: 49% of regular monthly income.
Our cash flow goes on the following:
- ‘I am so worth it fund’ – John and I have one of those each. Slightly over 3% of our monthly regular income goes to these account (equally distributed) and we can use this money on anything we want.
- ‘Play account’ – approximately 46% of our monthly income goes to this account which doubles up as an emergency fund and a store for ready cash for opportunities.
Our ‘Play account’ is kept at a level that John and I agreed; any over flow is invested in three different ways: safe (relatively) investments, liquid investments and the smallest part is risky, speculative investments.
That’s it! I hate budgets and dislike budgeting. These are so simple and easy to apply though that I used them. This is how we dealt with our debt super fast and are now sprinting towards financial independence.
Which of these budgeting approaches fits best with your life? I would love to hear what you think.