Budgeting Part 1 – Understanding Your Financial Position
Market Meditations | July 8, 2021
In this series, we will run through how to budget in a way that allows you to build wealth over the long term. We are not talking about saving $2 on your daily coffee, instead we are focused on real strategies that help you live the life that you want.
Part 1 (today) ➡️ Understanding Your Current Financial Position
Part 2 (15/07/2021) ➡️ Deciding How to Spend Your Money, Setting Goals and Budgeting
Part 3 (21/07/2021) ➡️ Sticking To and Updating Your Budget
? Financial Literacy
Before we dive any further, we need to understand the concept of financial literacy, and why it’s so important. Simply put, financial literacy is the ability to understand and use financial skills that dictate your relationship with money. It is the ability to make your money work for you, rather than the other way around. There are 5 components that you need to understand.
- 1️⃣ Earning gives us the potential to bring more money into our ecosystem, through a job or activity such as trading. Always look for ways to maximize your earnings, whether this be negotiating a raise, setting up your own business on the side or if you have professional skills, freelancing.
- 2️⃣ Saving and investing covers what happens next to the money you receive through earning. Saving is simply the act of not spending money and investing is the ability to grow your pool of savings whether this be through stocks, crypto, real estate or other such financial asset.
- 3️⃣ Spending. We are certainly not proponents of trying to cut every cost imaginable and in this series we will propose several means of budgeting effectively, whilst still being able to afford the things you love in life, whether that’s travelling, eating, or buying nice clothes.
- 4️⃣ Borrowing relates to acquiring debt (think mortgages and credit cards) and is one of the most misunderstood and potentially damaging components.
- 5️⃣ Protecting deals with how to ensure you preserve the pool of money you are building up through the other 4 components. Typically this relates to insurance and avoiding unexpected bills however we think there is more.
? Understanding Your Position
Now that we understand the 5 components of financial literacy. Let’s start applying it to budgeting. Before we look forward, we must look backwards and analyse our financial position. To do so consider three categories, spending, income and net worth.
- What are we spending on a monthly basis? This information is normally easy to find with the majority of our transactions being downloadable from our bank (if not you can always keep receipts). Look through your transactions and break them down into several categories: Housing, Transportation, Food, Utilities, Insurance, Recreation and Investing.
- ✅ Within this you can ask yourself what is a base level of spending required to live and what is merely a nice to have. To leverage some examples, whilst food is an essential cost, buying steak, sushi and caviar everyday of the week isn’t! Similarly, if you need to drive to work, a car is essential, however purchasing a brand new car every year probably is not. We are not saying you shouldn’t be spending money on nice to haves, just that you should be aware of where your money is going.
- Another consideration is which of these costs are fixed such as bills, rent and investments most of which can be automated! To learn more, check out our guide on automating your finances.
- For those that work a salaried job, this is simply the post tax income you receive each month. For those that are self employed, assess previous months data to ascertain a conservative estimate of what you can expect to make each month. When we come to budget this will dictate how much money we actually have to spend or save.
- The value of all your assets minus your liabilities. An asset is a resource with economic value such as cash, stocks, bonds, and personal items including jewelry and cars. Liabilities are something that you owe, usually a sum of money. This is a useful snapshot of our financial situation in one number and is especially useful when tracked over time to see our financial trajectory. To help we have provided a simple calculator that you can use.
- ⚠️ Knowing the number can also become a useful tool to manage your expenditure by asking yourself questions such as “how much is this purchase as a % of my net worth”. If you find yourself spending 10% of your net worth on an article of clothing, you will likely not be financially successful in the long run.
- Outside of budgeting, net worth figures also allow you to create more defined investment strategies such as deciding % allocations to different assets. However, do not place too much emphasis on net worth, this is only a number used to help us improve our financial health and it is by no means a measure of our happiness.
Now we know these 3 key pieces of information, our monthly costs, income and total net worth, we will be able to decide how much we want to spend and how much we want to save in order to grow our net worth and meet our financial goals!
Gaining financial literacy and understanding our current financial situation lay the foundation for building wealth. Understand the 5 core components of financial literacy, learn to assess your financial life, and you will be well on your way to financial success.
In part 2, we will dive into creating the budget itself. At Market Mediations, we understand that everyone is different and whilst some may like creating rigid rules and exact calculations, for many, this approach is simply not sustainable (or enjoyable!). Similarly some may be happy to live frugally in all areas of their lives but that may lead to a miserable existence for others. As such, we will be sharing strategies that anyone can use to build wealth whilst living a life that makes them happy.