How to Budget Part II: Allocating Your Income to Save Money
If you go online and search for budgeting or savings, it won’t be long before you come across the 50/30/20 rule.
It suggests that 50% of your income should be spent on essentials, 30% on luxuries and 20% on savings.
For most people in the UK, the 50/30/20 rule is a joke.
The 100/0/0 rule
For many people living in the UK today, the real truth is that they are juggling a 100/0/0 rule, where all of their money goes on living essentials and there’s simply nothing left for anything else. Of course, this cannot go on for long before the system breaks down and you end up in horrific amounts of debt, but to deny that it happens is negligent.
As explained in part one of this series, one of the first things to do is to be honest and properly categorise your expenditures – Netflix is not an essential, neither is tinned pineapple or a packet of Doritos, even if you can argue that they come under food. Be realistic and see if you can move your perspective from 100/0/0 to 90/10/0 or better.
If you are really living with a 100/0/0 situation then you need to do one of two things:
Increase your income
Lower the amount of essentials
Neither of these are easily done, but both are possible (even if they mean a major change).
Increasing your income
Before writing this off as impossible, consider the following:
Find out more about your benefits to see if there is anything you can claim for that you are not getting.
Ask your employer for a small raise and explaining to them that you simply cannot go on as it is.
Look for a new job or second job.
Increase the time that you spend searching for a new job if you are already doing so.
See if there are other avenues of income available to you (a regular monthly donation from a parent that you don’t need to pay back, for example).
While many of these may seem hard, they are possible and should be considered if you are living a 100/0/0 lifestyle.
Lowering your essentials
As difficult as increasing your income, lowering the cost of your essentials may mean:
Walking or cycling rather than using paid transport.
Re-evaluating your diet and food – cooking at home from scratch is significantly cheaper (and healthier!) than buying ready meals, frozen food or take away.
Moving home to a cheaper area.
Arranging payment plans or debt consolidation to pay off existing debt in a more suitable way.
Hopefully you are not struggling hard in this way but if you are, it is important that you get help. Contact your creditors and see if they can do anything to lower the stress or call the citizen’s advice bureau for some free financial advice.
Real Britain – the costs of living
There’s no getting around the fact that the UK is a very expensive place to live and the amount of free money that most people have at the end of the month is very low indeed.
The average salary in the UK according to 2018 figures from the Annual Survey of Hours and Earnings was £28,677. That works out at around a little over £1,900 take home per month.
The average rent alters drastically by region, but it’s safe to say that most people renting a property pay in excess of £750 per month (and much more when you get closer to London, where average rents top £1500 per month).
Council tax immediately adds another £120 or so per month, fuel costs typically exceed £100 while communication pushes another £50 onto the bill. Already, we’re well past the 50% line and nothing has been considered for travelling or food.
The costs of commuting to work for an average person are more than £200 per month, and if you spend less than £100 per month per person on food, you are doing exceptionally well – that’s only a little over £3 per day!
£1,900 take home salary might seem a lot at first glance but put a little pressure on it and it can crumble fast. Add supporting a family to the equation and even with two earners in the household it can be a struggle – try to survive with a single breadwinner and it’s no wonder money troubles are the greatest cause of stress in the UK.
How budgeting can help you find that extra money
It’s not all doom and gloom, however. Taking control of your money and really understanding what comes in and what goes out means you can keep a tight rein on your funds and live comfortably even on a less-than-average income.
Once you have cut out those non-essentials as described in the first part of this series, you will soon see control return. The chances that you are not really using 100% of your income on essentials are high – and even if it is 80%, that’s a good chunk left over to improve the situation.
Now it’s about choosing what to do with that left-over cash.
Now or the future? A look at what drives you
Only you can tell you what kind of person you are. When it comes to financial planning, the chances are you are one of two types:
A live-for-the-now person, eager for new experiences.
A security-is-important person, looking to save for the future.
Neither of these types is wrong. For some, the idea of putting aside their money for a hypothetical future they may never see is simply horrific, while for others, anything spent today seems irresponsible when the funds could be used to secure a good retirement.
Thankfully, at Compare UK Quotes, we understand both ways of thinking and have advice for you no matter where you fall on the spectrum.
Short-term thinkers – seizing the day
There’s a lot to be gained from being willing to act on impulse and have fun with your money. As long as you have carefully budgeted your essentials and any money you spend is spare funds in excess of your needed expenditure, no one should feel they have the place to judge what you do with it.
Some short-term enthusiasts like to do things like go out often, explore the world with impromptu holidays or simply indulge in fine meals when the mood takes them. Others will look to make their current environment a pleasant one, with comfortable furnishings, the latest technology and an array of subscription services to keep them entertained in the evenings.
Remember – as long as the essentials are correctly budgeted, there’s no problem at all with spending your money in this way.
The problem comes for short-term thinkers when the desire for instant enjoyment exceeds their available funds, they become enticed by easy-to-achieve credit without correctly thinking it through.
When credit is bad – unplanned and unbudgeted debt
At Compare UK Quotes, we are advocates of properly-managed credit to help you achieve the things you want, but we are keen for you to only take out credit that you can properly afford and not fall into a spiral of cascading debt that makes you suffer.
If you budget your money well, and keep on top of your outgoings, then your credit rating is going to improve, and it won’t be too long before offers for credit cards or personal loans are going to arrive through the letter box.
Simply jumping at the first offer because it gives you instant access to that holiday, or a brand-new TV, is a very bad idea.
Remember – credit payments form part of the essentials section of your budgeting and that means for the next few years, until any credit is paid off in full, the percentage of your income that is locked away to pay for those essentials will increase. If the loan is too high, it might even leave you with very little spare funds each month.
Imagine the situation where you have been living for six months with a perfectly well-budgeted excess of £300 per month. You have enjoyed meals out, a weekend break to Europe and even bought an extra comfy chair.
Now the offer of a £10,000 loan comes in, at a low repayment cost of £250 per month. Technically you can afford it, but for the next few years, your £300 a month is going to find itself diminished to a mere £50 – little more than a single night out every four weeks. Are you really prepared for that?
Over stretching at this time will leave you struggling for years and unless you are going to cut back in another area or are expecting your income to increase, it is a very bad idea.
In truth, short-term thinkers should avoid additional credit wherever possible and limit themselves to using only genuinely available funds.
Long-term thinkers – planning for the future
While the short-term enthusiast might want to spend any unallocated budget on regular entertainment and enjoyment, the long-term thinker is looking to improve their lot later in life, by doing the hard work now and freeing up funds later.
The long-term thinker either has, or is looking at, a mortgage - renting is not a long-term ideal. The long-term planner is looking forward to a retirement when life isn’t taken up with working and dealing with young children but is a long stretch of free time where extended trips to see polar bears in the arctic or witness the wonders of the Amazon rainforest are within reach.
What does the long-term planner spend that extra budget on?
Getting a mortgage – the budget advantages
Where an average rent tops £750, the average mortgage in the UK was closer to £670 per month. That’s an extra £80 per month to help with general living costs and at the end of the day, you own a house!
There’s no doubt that if you can afford the initial deposit and have the required credentials, buying a house is a desirable thing to do for your budget, although you will be responsible for any repairs that would be covered by a landlord in a rental situation, and depending on the property, that could prove more expensive than the amount saved by taking out a mortgage.
It could be, of course, that you are saving for a deposit on a house that you hope to buy in a few years – another valuable long-term goal.
Being able to buy a house is a huge financial goal for most people and with correct budgeting and a non-frivolous lifestyle, it should be within reach for everyone.
Looking at life insurance and critical illness cover
Life insurance is best taken out sooner rather than later – your health is a major factor in determining the cost of your insurance premiums and it tends to be true that younger is healthier.
Critical illness cover is a subset of life insurance that pays you a large lump sum should you find yourself ill with something that prevents you from working.
Both life insurance and critical illness cover are essentials for the long-term planner who is providing for a partner and children. You can read more about both in our library of articles here on Compare UK Quotes.
Savings and investments – making the most out of your money in the long term
Putting aside your spare income for later will provide a level of security that cannot be replicated in any other way – and not only does it give you access to the funds you have collected, but in showing such smart financial planning, you will build up a solid credit report, giving you access to larger and cheaper lines of credit should a large sum ever be needed in the future.
There are many ways to save and invest money, ranging from low risk / low return savings accounts to high risk / high return investments. It is up to you which way you go, or whether you try out a mix of saving and investment options.
Your savings and investments are likely to grow, so make sure you properly shop around to find the best rates for you. Each person is entitled to an ISA which is tax-free, and if you are saving to build a deposit on a mortgage then there are special ISAs where the government will help out with a boost if you meet the criteria.
For more information on savings and investments, read our articles on the subject.
When credit is good – planned credit for long-term improvement
While credit in the hands of a person with an impulsive nature may be a dangerous thing that can lead to a downward spiral of debt, utilised properly, credit provides a platform for personal financial growth and management that cannot easily be achieved in other ways.
Whether it’s a mortgage, a car finance agreement or a personal loan, well-managed credit gives you the opportunity to plan your spending in a way that suits you. Make sure you properly budget the repayments and never take credit out that is going to stretch you beyond your budget, but credit can help you buy a home, start your own business or give you a much-needed break from all the hard work you are doing.
For more information on credit, whether its interest rates or how your credit rating is calculated, take a look at our huge range of articles on the subject.
Giving the 50/30/20 rule a second chance
When you are struggling to budget and find your financial feet, the 50/30/20 rule is unrealistic and can lead to despair. However, after a few years of careful money management, it will start to be within your grasp. An appropriate house purchase and good mortgage, proper understanding and management of regular outgoings and an acceptance of your personality type is going to give you years of strong financial security that will eventually lead to a good standing.
Look to the 50/30/20 rule as a goal, rather than an immediate judgement, and it can help you to live a long, financially-stable life.
Join us in the third part of this guide to budgeting when we look at the tools available to help you with all your financial planning!