Whilst a budget is a great way of observing where your money is going, it is really a tool and it should be used to serve a purpose: meeting your financial goals. Take companies for example. They set the budget at the beginning of the financial year in order to keep their expenditure within certain limits. This ensures that at the end of the year when they draw the line, they are left with a profit. The budget allows for monitoring of expenditure and appropriate remedial action if necessary, to make sure that the profit target is met. Of course there are other factors involved and this example is a very simplistic one but it serves well do demonstrate the power of budgets.
Similar to companies, you should always set a budget with a purpose in mind. This can take various forms: saving an amount of money for the year, reducing your monthly expenditure by a certain percentage, building up your emergency fund, etc. Don’t forget that budgeting is a tool and you should use it as such: an enabler of something else, in this case a financial goal.
Setting your financial goals
I recommend being very detailed about your financial goals. We’ve all heard of the SMART acronym: Specific, Measurable, Achievable, Realistic and Timely. Let’s look at what a SMART financial goal might look like:
My goal is to save £4,000 by dd/mm/yyyy (insert whichever date is relevant in your case). This is Specific and Measurable as well as Timely (or time bound). Whether it is Achievable and Realistic depends on your own circumstances: your level of income, the expenses you foresee until your goal date, your debt level, the number of people which depend on you financially, etc. To make it Achievable and Realistic you might have to tweak it. For example: my goal is to save £2,000 by dd/mm/yyyy, or whatever number is appropriate for your circumstances.
Assuming that you wish to reach the above goal a year from now, ideally the bottom line of your annual budget, after deducting all your expenses from your income for the year, should be equal to or greater than £4,000 (or whatever number you chose). Hopefully by now you can see why a goal such as “I want to be financially secure” is too vague. It is not specific enough and it’s very difficult to measure financial security. You need to provide as many details as possible so that when you review your budget you can assess whether you have reached your goal or how far you are from achieving it.
Take some time to determine what your financial goals are before starting to work on your budget. By all means challenge yourself but be realistic. If your annual income is £25,000 and your financial goal is to save £20,000 you might find that you’re pushing yourself too hard, unless you foresee a significant increase in your income or a drastic decrease in your expenses. You will lose motivation if your goal is not achievable. You can always change it later, so start with something that will challenge you but is within your reach if you discipline yourself. Make it realistic and achievable, believe that you can do it and you will!
Now that you have set your financial goal(s) you can move on to the next step which is distinguishing between different types of expenses.
Until next time, stay savvy!
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