After Pareshbabu left, Arvind and his wife sat down to decide where to begin.
“We need to go to the bank and open bank accounts and ask about how we can get loans and make deposits...” said Arvind, still thinking about all the money he could save by borrowing from a bank rather than Dharampal, the money lender.
Vimla, a typical housewife, brought to his notice that it was equally important to get their budgeting exercise right. “Pareshbabu’s story of Ram and his wife made me realise that unless we first understand how we are spending our money, we will never know how much we can save...We seem to be saving just by chance. That is our problem.”
“True. Let us correct this problem. I recently heard on T.V. how budgets are very important for any unit that manages money...right from the Government to companies and families and individual people too. Naturally, the type of budgeting done at various levels is different.”
“So why don’t we also start creating a budget?” said Vimla, rushing off to bring her pen and paper.
Creating a budgetA budget has four main pillars:
It helps you to realise exactly how much money is coming from different sources. In the case of our little story, Ram was the only earning member and there was no other source of income. In your case, consider all your sources of income....How many earning members are there in your family? Do you get a regular amount of money from any other source such as rent, interest on fixed deposits or other financial products, dividend from shares, etc.? Do you sometimes receive a bonus and how sure are you that you will receive this bonus? All these questions will help you to calculate your income.
It helps you to estimate your expenditure. It may not be correct to keep track of your expenses for just one month and come to a conclusion about how much you spend. You will need to keep track of your expenses for at least 3-6 months. This is because there are certain expenses, some large and some small, which occur once in a while – repairs, celebrations, etc. These may not be captured in the expenses on one month.
This is the amount of money that you have collected over the years in various assets. While it does not play an active role in your budgeting exercise, it will give you a good idea about how much money you have. This comes useful when you plan your goals. For instance, if you have adequate money saved up for a goal, you will not need the help of a loan. You may have to set aside less funds from your income to achieve your goals if you already have money saved up for it.
This is also an important part of your budgeting exercise as it tell you how much money you have to return to your lender. Ideally, you should have a clear plan for repaying your loans. This means you must be clear about how much you plan to pay back and at what time schedule.
These four pillars of a budget help you to monitor your spending and control it, if necessary. More importantly, they allow you to plan how to save and invest for goals.
How to budget
In the days gone by, it was believed that budgeting was an exercise that followed the following procedure:
People used to spend money on various household and other requirements and save whatever was left. Then, they would wait till the money saved every month reached a “good enough” amount. They would take that amount and save it in the most attractive investment product available at that time.
But now financial experts have come to the conclusion that we must first set aside a fixed amount of savings. These savings must be immediately invested as per a plan. This plan must be created on the basis of our short term and long term goals. Then we can spend whatever we are left with, which is usually around 70-80% of our regular income. This puts your goals as your priority and ensures that you spend in a disciplined manner.
Life is never predictable. Today, everything seems to be going as planned and suddenly tomorrow, something unpredictable happens and changes the very basis of your plans. And when this happens, how does it affect a budget? More importantly, how does it affect your ability to meet your goals?
For instance, consider the case of Dinesh and Meera. This young couple live alone in a small city away from their hometown. Dinesh works in a mid-sized company as an accountant and Meera is a housewife. They have no children yet.
Dinesh’s parents live in their ancestral house in their hometown. His father is a retired government officer. They have always lived a humble life. They never had any serious financial problems and always lived comfortably but they never owned their own vehicle or went on expensive holidays or spent on grand celebrations.
Their 25th wedding anniversary is fast approaching. Dinesh and Meera want to surprise them by gifting them a Nano car. The young couple are well aware of the process of financial planning and how it can take them closer to their goals. As a result, they have been saving up for the past 3 years and investing regularly in a recurring deposit. The deposit will mature about 6 months before Dinesh’s parent’s anniversary and give them a total amount of Rs. 1.5 lakh.
All of a sudden, they receive a call from Dinesh’s mother telling them that papa has had a stroke and although he seems fine now, he has been advised to do an angiography – a test to check whether he has any blocked arteries. Dinesh and Meera insist that the parents come to stay with them in the city and get the test done there. It turns out that Dinesh’s father has a block and the doctor performs a successful angioplasty (procedure to remove the block) on him.
Dinesh’s father has health insurance. However, it was not enough to cover the cost of the treatment in the city. Dinesh pays for the balance of the treatment from the money he had saved up to buy his parents the car. Meera and he decide that they were lucky that they had saved up enough to pay for the treatment or else perhaps they may have had to take a loan. They also assure each other that they will start saving again and buy that car for their parents a couple of years from now.
The lessons from this little case are
- Financial planning does not need to be discarded in an emergency; it must be carefully altered to suit the situation. Later it can be set back on track for the same goals.
- Always set aside some money for emergencies; one can never tell when they will pop up. The best way to plan for emergencies is to ensure that the family has adequate health insurance and the main earning member has enough life insurance
Always purchase adequate insurance, especially health and accident insurance. For a small payment every year, you can protect yourself from a situation where in a trip to the hospital upsets all your carefully planned finances.
Dealing with a money/ debt crisis or financial emergency
Quite often, a family can be burdened with loans that remain unpaid from year to year. The interest on such loans keeps increasing, despite the family’s efforts to repay them. At such times, budgeting for the loan should become the focus of a family budget. Here are some steps that can be followed:
- Transfer your debt to a lender who charges a lower rate of interest: Sometimes, as in the case of Arvind, people borrow from money lenders, who charge a very high rate of interest. When they are unable to pay back the amount with interest, within the specified period, the period is extended. But with increase in tenure, you also end up paying a much larger amount as interest. The family keeps struggling to pay off the interest component and never manage to pay off the actual loan. In such cases, you must find out if a micro-finance institution or bank in your neighbourhood is ready to give you a loan that equals what you owe the money lender. Even if they are willing to give you part of the amount, you will be partially free of the moneylender’s loan.
- Pay off your higher interest loans first: If you are not able to pay all your loans back at the same time, pay off those which have a higher rate of interest on them. This will reduce the overall amount that you have to pay.
- Make a very strict budget for yourself and your family: Nobody likes to live with loans. Try to first pay out at least 30 per cent of your income towards repaying your loans, or more if possible. Then, use the rest on your house hold expenses. Within household expenses, list out those that are necessary (food and education, etc.) and those that you and your family can do without, such as entertainment and spending on festivals and guests. Then try to do without the latter until your loans are paid off.
The rule to maintain while budgeting is that you and your family should ensure that all your loans do not amount to more than 1 and a half year’s income. Also ensure that all your payments towards your loan (interest and repayment) do not amount to more than 40% of your monthly income. Of course these are outer limits and you should try to stay well within them. The best precaution would be to save for your goals instead of buying them on loans.
Source: Portal Content Team