Budgeting

There was a time when a conversation about budgeting was completely unheard of, at least in “polite” public company. Canadians kept their money issues to themselves, and initiating conversations on this topic was generally considered invasive. Today, the topic of budgeting is everywhere around us, from lower school to post-graduate studies, and from home magazines to daily newspapers.

Budgeting is critical at all levels of society — from the lower-income segment through to the ultra-wealthy. Every family must prioritize where it is going to spend its income and how to make sure its income satisfies all of its needs. Financial disasters have affected many families from every level of income, but budgeting can help minimize the potential impact of a financial crisis.

Budgeting comes in many flavours and styles. Today, it is common for individuals and families to work with a financial planner to develop workable strategies that help accomplish specific needs and goals.

One common form of budgeting is to “pay yourself first”. Under this strategy, a savings target is first established along with a target date by which the funds will have been accumulated. Knowing how much you want to accumulate, and by when, is the starting place. Then, the amount that you need to pay yourself is calculated based on an assumed investment rate of return adjusted for income taxes, and the timeline for the savings goal. Once the periodic amount of savings has been identified and the plan put into action, the target savings are carved out of the family’s monthly cash flow, leaving the remainder available for consumption on lifestyle needs. In this way, all items that are beyond the family’s monthly cash flow are cancelled or deferred, with the result that the family should be able to stay in balance and achieve their financial goals. Note that to make this strategy balance, there needs to be a level of reasonableness in savings targets so that the remaining cash flow is sufficient to address all fundamental financial needs.

Savings goals could include some or all of the following: long-term goals such as retirement, medium-term goals such as children’s education or a new home or cottage, and shorter-term goals such as vacations or buying a new car or boat.

Another strategy for creating a family budget, often referred to as the “cookie-jar” method, involves reviewing spending habits to isolate how much money is needed to support different categories of spending. Components could include both necessities along with lifestyle activities — utilities, rent, mortgage, property taxes, food, clothing, child care, travel and entertainment. These components can start to be quantified by reviewing the spending history from the most recent couple of months and then critically reviewing what would be appropriate to spend on each component. If there is no breakdown of historical payments, a forward-looking approach is to track the spending in each of these areas over a two to three month period. Be warned, however, that while two months of expenditures is a place to start, families must also keep in mind that much spending is lumpy (insurance premiums, for example) or seasonal (for example, snow tires or gardening expenses, school supplies, vacations, gifts, etc).

How a particular family chooses to develop a budget will depend on the circumstances of the family and their ability and determination to stick to a plan. More important than the type of plan is the ability to stick to the plan and review it periodically to account for changes in family circumstances and goals. A financial planner can help not only in setting up the original budget plan but also in its periodic review and assessment of progress.

E.O. & E.