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Why a Household Budget is Important

For most Canadians when we hear the word budget we automatically associate it with negative feelings of things like spending restrictions, making tough spending choices, and the realization that there are financial limitations on the lifestyle we desire. We view budgets as oppressive and unpleasant because they tell us the things we don’t want to hear: “No, you can’t afford that …

 

So, how should a budget be used?

While these restrictive feelings certainly can be part of the budgeting exercise, InvestingForMe prefers to look at budgeting just like a company or corporation does. For companies, budgeting is a tool that helps to ensure that the company’s limited financial resources are used wisely. They view the budgeting process as their guide to decision making to ensure that resources are allocated toward the most profitable and efficient activities that help the company to achieve its financial and business goals. And that’s how we suggest you see budgeting as well. By completing and managing a budget, you are simply identifying and allocating your income to those activities that help to maximize your lifestyle and achieve your financial goals.

Understanding the usefulness of budget itemizing

Working your way through a proper budget, line-by-line, means itemizing or identifying all your living costs, and yes, this exercise can seem a little tedious! But try to adopt a more positive attitude toward budgeting and the allocation of your hard earned income! Budgeting is a tool that helps to ensure that you receive the maximum benefit from your spending. It’s your right to get as much as you can from each spending decision you make. You work hard for your money, so you need to ensure you are making the most efficient and profitable spending decisions.

For each expense listed in your budget, you should ask yourself the following questions:

  1. Is this expense item a need or a want?
  2. If it is a need, are you getting the best value for the money you are spending? You must ensure that you are not over-paying for the item. A budget helps you to question and examine the cost and benefit of each expense.
  3. If the expense item is a want, you should yourself if it is important to your lifestyle. If not, then it can be eliminated. If it is important, then again, check if you’re paying too much for the item. You may have committed to the item expense years ago not realizing that you can pay less for the same item today. (Sometimes it’s as simple as asking the item’s provider to give you a better price or maybe a competing provider can lower your costs.)
  4. Is the expense item permanent or temporary? Many expenses have a limited life (children’s activities, education costs, car payments, mortgage, RESP contributions, etc.). Understanding the expense item’s time frame can often help you to adjust your spending to ensure the most successful outcomes. Accept that financial and lifestyle circumstances change and your budget must be flexible to adapt with those changes.
  5. Is the expense item a duplicate expense? For example, you may be paying for extended medical, dental and insurance benefits you already receive from your spouse’s employer. Many expense decisions are made in isolation of each other and, thus, you may end up duplicating expenses.

Why you should bother:  an interesting comparison

Lots of people think they just can’t be bothered with budgeting. But unless you have a limitless income and money is just not a concern, you should have an understanding of how you spend your limited income. The majority of individuals that find themselves in financial trouble are working and receive a regular income. They have jobs, they work hard at those jobs, and they still cannot make ends meet. They cannot get ahead of their financial troubles because they have no idea where their money goes.

Budgeting helps to ensure you receive the maximized benefit from each spending decision and it helps you to identify your spending priorities in relation to your financial and lifestyle goals. Take a moment to look at the following chart of common household expenses and the long-term financial costs for each of these items.

 

Expense

Monthly Amount

Annual Amount

Stuffed under a mattress

for 40 years

Invested @5%

for 20 years

Invested @5%

for 40 years

 

 Cell Phone:

 

$75

 

$900

 

$36,000

 

$32,088

 

$117,225

 Smoking: one pack

 per day @$8.00

$243$2,920$116,798$103,962$380,323

 Coffee: Starbucks

$106$1,277$51,100$45,350$166,397

 Beer: 2 cases per

 month

$46$552$22,080$19,680$71,896

 Wine: 4 bottles

 per month

$60$720$28,800$25,669$93,778

 Internet: High-Speed

$47$564$22,560$20,108$73,461

 Car: Increased cost to lease  vs. finance a  purchase*

$93$1,121$44,856$39,981$146,061

 Investing costs**

 

$200$2,400$96,000$85,566$312,597
Totals:$870$10,454$418,194$372,404$1,361,738

 

      * Assumes Loan and Lease is renewed every 48 months to purchase a $20,000 car. See our Automobile Financing Comparison tool.

      ** Assumes $100,000 invested in mutual funds with an average annual Management Expense Ratio (MER) of 2.40% per year.

 

Now, just for fun, take another look at the list and identify how many of these expenses your parents or grandparents would have incurred. If you are a baby-boomer, then it might be safe to say that your parents did not have expenses for cell phones, Starbucks, high-speed Internet, automobile leasing and annual investment management fees. So, when compared with today, your parents worked, raised a family, and had the ability to accumulate approximately $815,741.00 simply by not incurring these particular five expenses. This expense comparison simply demonstrates that saving for your retirement is not as easy as it might have been for our parents or grandparents. Yes, they did not have cell phone or Internet expenses, but do you think you could live today without these services? Almost impossible! So do not approach the preparation of your budget with the goal of eliminating expenses indiscriminately. Use your budget as a tool to ensure your financial resources are allocated wisely.   

Get behind the idea of a budget

In order to prepare a proper written Household Budget, you will need to understand the following four budgeting concepts:

  1. Budgeting is a team sport. Before you go any further, you must make sure that all participants agree on the need and benefits of preparing a budget. If you have a spouse, your spouse must accept and support the concept of budgeting. If you cannot agree on the importance of a budget, then budgeting becomes simply a less useful exercise in tracking your expenses, but without managing them.
  2. Budgeting is also an information sport. You will need to gather together bank account, credit card and investment statements, income tax returns and income tax assessment forms, property tax notices, etc. before you can begin constructing a proper Household Budget.
  3. Budgeting requires a time investment. You must be willing to commit your time to prepare an accurate and useful budget. Once your budget has been completed with your historical expense information, you must also commit the time to analyze and question each expense item and, for some expense items, you must spend time hunting for the most beneficial item at the lowest cost.
  4. Budgeting is made easier by using good tools. Use the Household Budget found in our IFM Tools section to help you complete and manage your budget. This tool is very comprehensive and enables you to track your expense items for a running five-year period.

Getting down to business

The Household Budget is comprised of two main sections: The Sources of Annual Income and the Sources of Expenses. To make the job of sitting down to tackle all this information easier, you should first gather certain documents together that will provide you with the most recent income and expense information. (Taking the time to hunt and gather your financial papers is probably half the battle.) Here’s what you’ll need for filling out each section of the budget:  

  1. Sources of Annual Income section: Most recent Income Tax Return. Make sure it is a complete return with copies of your income tax slips – T4, T5, T3, T4A, T4-RRIF, RRSP contribution receipts, etc. Your income tax return and information slips will provide you with the majority of the information you need to complete this section. From your tax return and slips you can determine your income, income deductions such as income tax paid, EI and CPP premiums deducted, Dividend, interest and trust income, etc.
  2. Sources of Expenses section: To complete this section you should have copies of statements for your bank accounts, credit cards, household utilities, property assessment notices, etc. For some expense items you should have at least 6 months (preferably 12 months) of statements available. The account statements will help you to identify and, in some cases, estimate your annual expenses.

Note: The accuracy of your income and expense details is critical. The old saying “Garbage in, garbage out!” applies here. If you are simply going to guess at your income and expenses, then the benefits of completing a household budget are minimal at best. If you do not know the exact amount of an expense, then do your best to estimate the number, but update it immediately when the item next arises.

Note: In our IFM Budget Lines section we discuss budget income and expense items in greater detail. As the saying goes, “The Devil is in the detail.” By accurately itemizing each income and expense item you will create a powerful budget-planning tool. How you categorize each item is important in determining your true financial picture. For example, do you view contributions made to your RRSP or RESP accounts as expenses? You should, as these are ongoing expenses, just like your rent or mortgage payment is an expense.

 

 

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