Personal Financial Planning – Managing Expenses (III)

Last week, we began discussions on personal budget and its importance along at least two dimensions. First, it enables us to monitor our inflows (revenues and earnings) and determine how we utilise or misuse them (through expenditures, savings, and investments). Second, it allows us to plan and work towards achieving our various financial and non-financial […]

Last week, we began discussions on personal budget and its importance along at least two dimensions. First, it enables us to monitor our inflows (revenues and earnings) and determine how we utilise or misuse them (through expenditures, savings, and investments). Second, it allows us to plan and work towards achieving our various financial and non-financial goals. But we also posited that, unfortunately, we are a people not too inclined to developing budgets and striving to live by them. Why?I believe that some of the reasons why many of us don’t budget include the following:

The income-expense ratio: Each individual belongs to some space in a spectrum of what I call income-expense ratio. An income-expense ratio (calculated by dividing our income by our expenses) brings out what we earn over a period of time vis-a-vis our expenses over that period. It goes without saying that a high income-expense ratio signifies a very comfortable coverage of expense by income made, and a low income-expense ratio indicates a low coverage of expense by income made over the period. A ratio of less than one means expenses surpass income over the period being considered.

At one end of the income-expense spectrum are individuals whose income does not cover their periodic needs, while at the other end are individuals whose periodic expenses are infinitesimally small in comparison to their income. In the former case, the individuals might think a budget wouldn’t help, and in the latter case, the individuals might think it is unnecessary. Each is a type of error that should be avoided for different reasons. In some situations, people think budgeting requires some impossible mathematics that they cannot handle.At other times, individuals can feel secure about their jobs and think they don’t need to plan. But empirical observations suggestthat many jobs are not as secure as they may seem or used to be. 

 The psychology: Many of us feel wired to spend. That is why we ‘go shopping’ even when we have not listed out what we need to buy for what reasons and without much regard to whether we can afford it or not. Often, we buy goods and services on impulse and later realise that we really don’t need them, ending up with a stockpile of products of not any value to us but which have cost us substantial amounts. Other times we also just buy to ‘belong’. Our friends and neighbours buy some things that are in fashion and we feel obligated to also buy. Many of such purchases were not wisely thought out. The discipline of both a budget and self leadership is required for us to avoid such errors.

Other reasons why we don’t budget include:

Social pressures:  In our country and indeed Africa-wide, one of the factors that makes it difficult for many of us to budget is social pressures. By our culture, we are expected to, as much as ‘possible’, oblige requests from the needy in our families, amongst friends, to those we meet on the streets. This is almost with little concern to our personal financial safety and realities. These make things more difficult, particularly for people whose income-expense ratio might be higher than unity but with not much margin of safety. 

Irregularity and inconsistency in earnings and spendings: For the individual who doesn’t have a predictable income over any period, and particularly when they are not earning much, they can reckon that drawing a budget doesn’t make any sense or offer any value. Similarly, persons with irregular spendings can also unreason along the same lines. 

Fear: A diligent budget brings out our fears. How much are we earning? How much are we spending to maintain bad and unwise habits? Consequently, we may avoid drawing a budget like the proverbial ostrich that buries its head to avoid seeing and, therefore, confronting a challenge.

Discipline is required: Diligence in ensuring that we conduct the budgeting exercise thoroughly, thoughtfully, and realistically might be absent in some of us. This means we do not wish to put ourselves through the mental and physical rigours required. Instead, we opt to coast along by the day, hoping for the best.

Limits: Budgets can create limits for us as to what we can do, when and to what extent. Purposely, budgets can bring out points and issues that may need tough actions, such as dropping bad habits and deferring gratification. So, if an individual believes a budget will only constrain them from ’enjoying themselves’, they would not likely be engaged in drawing it. 

To be able to draw functional budgets for our benefits and long-term financial success, we need to understand and internalise its benefits. Even for persons with an income-expense ratio of less than one, a budget will force them to prioritise those spendings that are most important and ensure that they get the most value for each Naira spent. For those with a ratio higher than one, budgets will ensure that they are able to seize opportunities for building wealth. Regardless of where you are on the income-expense spectrum, if done well, budgeting will help you to create discipline, focus and financial success