Financial Planning Basics – Budget Planning – The bits that go missing

Ian King, Thursday November 14, 2013

My previous blog posts have identified that a key element within any effective financial plan is the undertaking of a thorough budget planning exercise. I would now like to discuss the importance, when producing your budget plan, of widening the scope of your analysis, rather than just focussing upon your everyday expenditures.

Income and Core Expenditures

When starting your budget plan it is vital to list all of your monthly income and then to consider all of your regular monthly expenditure items.  Most people start by listing what I term as “core” expenditures, e.g. those which they see coming out of their bank account every month.  Examples here would usually include;

• Mortgage/rent
• Food,drink and household products
• Insurances e.g. buildings & contents
• Utility bills
• Travel expenses e.g. car fuel etc.

Items that people often forget

It is also important to budget for other items that people can often perhaps consider to be one-off lump sum payments due when the need arises. However, such expenditures are often habitual in nature and whilst these expenditures may not arise every year any truly prudent budget plan must consider them.  Examples of such discretionary items include;

• Holidays
• Car depreciation
• White goods
• Property maintenance
• Gifts.

Example

Imagine that you currently own a car that is valued at £5,000 and if you were to replace your car today you would likely spend a total of £10,000.  However it is likely that you will actually replace you vehicle in (say) three years’ time when your present vehicle may have depreciated to, for example, £2,000 in value.  At that time the equivalent car to what you would purchase today would still cost you £10,000 (inflation adjusted), therefore meaning that you would need to find £8,000 to replace your car, rather than the £5,000 that it would cost you to do so now.

This £8,000 lump sum can be incorporated into your budget planner by dividing the £8,000 by three (the number of years until you replace your vehicle) and then again by twelve to convert into a monthly expenditure.  As a result you would need to save £222.23 per month over the three years such that you could cover the cost of upgrading your vehicle.

Proper planning

If you produce a proper budget plan, which includes all of your possible expenditures, it can reduce the risk of being left with a cash shortfall when you need to replace an item, as in the example above or for a household item like a television. Having such an understanding is vital, both for people who are dependent upon living within either a fixed pension or variable investment income but also those who are yet to retire but are seeking to maximise their long-term savings.

Impact caused

At some point, we will all have these expenditures arise, whether we need to redecorate to maintain the fabric of your property or need to replace the washing machine, so it is important that you plan your finances in a manner which budgets for this.  Crucially, a proper budget plan significantly reduces the need to tap in to your ‘rainy day’ funds.  Once your ‘rainy day’ funds are used up, often your only likely option would be to reduce your standard of living.

If you would like us to send you a copy of the budget plan we use with our clients, The Budget Extender, which details all of the possible expenditures listed, please get in touch and we can email you a copy.

As always, if you have any comments please get in touch and leave your comments below.

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