Episode 4: Budgeting Basics Part 1 (Personal)
Updated: Jan 15
We dove into personal finance, budgeting, and debt repayment strategies in this week’s episode for Part 1 of the 2 part Budgeting Basics series.
In this video, I talked about how there are 2 parts to personal finance and budgeting:
The Brain, which encompasses the math, formulas, and general knowledge that I (and many other resources) can pass onto you.
The other part is The Heart, which is the emotional side of money management. This is the part that comes from within, your own goals, needs, and wants combined with self-discipline, will-power, and motivation. I mentioned in the video many times that while the math may be fairly simple, budgeting isn’t easy for The Heart, but I believe that you can and will reach financial independence if you really put your heart to it.
STEP 1: BUILDING A BUDGET
Things you’ll need:
• Bank and credit card statements for the last 3 months
• Last year’s tax returns (especially if you are self-employed or have other irregular income)
• A list of all of your debts, their balances, their monthly required minimum payment, and their interest rates – this can be found through statements, pulling your credit report (which is free through equifax), written letters from collectors, etc. Include your student loans, credit cards, lines of credit, old bills that have slipped through the cracks, payday loans, family loans, etc.
When we’re building a budget, the first thing we need to figure out is our total income AFTER TAXES (including all family members who bring in money, child tax benefit, support payments, investment income, etc.). You can find this information on your bank statements, pay stubs, and if you’re self-employed or commission-based, look at your NET income after taxes from last year’s tax return. If there’s some reason that you believe your income will be different this year than last year’s make your best estimate, but be conservative. I’d far prefer you having extra money that you didn’t budget for than over-estimating your income and stretching yourself beyond your means.
Next, we listed the 3-month average of all of our expenses – we broke it down by the following categories:
1. Housing (rent, mortgage, property taxes, house insurance, utilities)
2. Transportation (car lease or loan payments, insurance, maintenance, gas, car washes)
3. Life (Child care, support payments, groceries, phone/internet, medical, clothing, gifts, eating out/entertainment, gym membership, phone apps, software subscriptions, cable, travel, lottery, etc…EVERYTHING ELSE)
4. Debt Repayments (all debt repayments aside from mortgage and car loans)
5. Savings (include RRSP, RESP, pension, cash savings)
If you have items that you only pay once per year, like an insurance policy or property taxes, take that amount and divide it by twelve – you still want to budget for these items monthly so you don’t just have a giant bill to deal with. Same for items such as car or home maintenance – even though you may not spend on these categories each month, it’s a good idea to still carve out room for them in your budget so that you have some saved up for when the repair comes due.
Once you have all of your 3-month average expenses listed, add them up. Is the number greater than your monthly income? Then your budget is not balancing, and we need to go in and make some cuts until:
INCOME - EXPENSES = ZERO.
Go through your list and draw a RED STAR next to anything that alarmed you by how much you spent (i.e. eating out, spa trips). These are areas you need to be on high alert for.
Now go through and write a RED S (for shop around) next to anything that you feel might be reducible or cut completely – i.e. insurance, phone bill, internet, cable, gym membership. You’re going to know when you see it.
Here is a pie chart that is a general guideline for how much you should be spending in any one category. If you’re way out on one or more of these, you know where to cut the fat.
Now, once we’ve worked on our budget to try to get as close to the Life, Housing, and Transportation margins as possible, we can then focus on Debt and Savings.
While I still want you to continue to make your minimum monthly payments on all of your debts, our first major concentration is going to be building a $1,000 emergency fund. Carve out 10% of your budget to save $1,000 in as little time as possible. Also, create some definitions around what a true emergency is, because every time you take the money out of this fund, you will have to stop your debt repayment plan to top this fund up again.
STEP 2: DEBT REPAYMENT
The guideline says that 15% of your monthly income should be paid to debt repayment, but this is nothing but a health indicator. My goal for you is to get your debt repaid within 3 years. If you determine that you will pay your debts off within 3 years, and you’re still under 15%, you have a healthy debt load. If your monthly payments need to be higher than 15% of your income, so be it.
Calculation time! You should have listed all of your debts, know their balances, and know their interest rates. Enter all of your debts and interest rates here. In the DESIRED PAYOFF TIMEFRAME box, enter 36 months. It will then calculate how much of a monthly payment you need to make (total, across all of your debts).
So now, we know the total of how much we need to pay on these debts to get out of it within 3 years, we’ve listed all our debts, we want to get aggressive with them 1 at a time (while still paying the minimum payments on the others) in order to optimize interest savings and psychological advantage. There are different schools of thought on what order to tackle.
1. Pay the highest interest rate one first. This is logical, it saves you the most interest over time.
2. Pay the callable debts first (banks have the right to “call” a line of credit or credit card at any time, even if you’re making your payments, so this means they say okay, credit is no longer extended to you, and you must pay that balance NOW or you’re going to collections) –many financial advisors would say to get rid of those balances first to avoid your debt being called on. This would also apply to urgent debts such as a car that is about to be repossessed or Canada Revenue Agency threatening to garnishee your wages.
3. The third method is called the snowball effect, where you pay your smallest debt first, and then move up to larger debts. The idea behind this is that it psychologically rewards us by giving us results right away, which motivates us to keep going.
I am personally in the camp of logic, which is pay the highest interest rate, or the most urgent debts first, but please do what works for you.
Several examples were given in the video to illustrate the points.
TIPS TO MAKE THIS EASIER:
• Your spouse needs to be on board. This takes serious discipline and focus to work. You need to be each other’s accountability partners. If you’re single, find an accountability partner, maybe your best friend, or a parent. Having somebody to vent to and keep you on track is so important in reaching your goals.
• Now that you’ve calculated your budget goals, you can use an app or an excel spreadsheet to track your progress. Some really great apps are YNAB, mint, or this awesome spreadsheet. But it’s important to do the work that we’ve gone through in this video first, so that you can recognize your own spending habits and take the appropriate corrective action BEFORE getting into one of these budgeting apps.
• Don’t budget for windfalls. So if you get a yearly bonus, don’t include it in your budget. I’d rather you be budgeting conservatively and then get a windfall that can either bolster your debt repayments, or go to something fun, rather than you banking on it and it not coming.
• For fixed expenses, you might find it easier to pay your bills every time you get paid. So, what this means is if your hydro bill is $100/month and you get paid bi-weekly, pay $50 every 2 weeks instead of $100 once a month. This will help keep your cashflow more even. For things that come straight out of your bank account, like mortgage or rent, you can set up a separate account (shop around for a free account) where every time you get paid, you send that divided amount to your “rent” bank account. That way you don’t have your entire rent paycheck coming out on the 1st.
• Be prepared to stumble. There are going to be times that you are going to go off track, and that’s okay, as long as you pull yourself back up again. It can be really helpful to read a book or listen to a podcast on budgeting to help you get motivated again. Trust me when I say that having no debt to worry about and a healthy savings account is going to be SO worth the time and effort you put in.
Next week we will be focusing on Part 2: Business Budgeting, how much you should be saving for taxes, and what a true profit looks like.