In the previous post we looked at the first part of the rules of budgeting mini-series. To kick things off we looked at budgeting the minimum living expenses, which we also briefly defined and categorized.
If budgeting for the minimum living expenses has depleted the entire income available then I would not move to this step yet but I would in fact aim to further reduce those expenses until I am able to create at least a 5-10% buffer of disposable income. That buffer's role would not be to remain unassigned to a budgeting category because then we run the risk of losing the discipline and impulse-spending it (Dave Ramsey has an awesome article here about impulse-buying).
Do you have monthly short-term debt repayments (either credit card debt or standard loan)? If yes, then this is where you put your disposable resources until that debt is reduced or eliminated. Hopefully, while you're chipping away at the debt, your income will rise. At this point it is not far-fetched to consider any option for earning more - get a side-job for a few hours per week, sell some of your old stuff lying around the house, anything you can do to augment the incoming flows on a monthly basis.
As soon as the debts are gone you move into financing your emergency fund.
How big should the fund be? Well, take it slow and steady:
- if you start from 0 money in your emergency fund then aim for 1 month's net salary.
- after 1 month's salary aim for 3 month's net salary.
- last step would be up to 6 month's net salary.
Opinions differ depending on where you're based. If you're in the USA then you will most often see the recommendation towards 6 month's salary. That is due to the fact that there is little employment protection and the worker can be hired and fired without too long of a notice period. If you're based in Europe then the unemployment insurance can provide you with some safety for a few months after having been made redundant.
If you want to guard against a black swan event like COVID-19 then you can't go incredibly wrong with just aiming to have 6 monthly net salaries in your emergency fund.
Once your fund is full, you want to stop allocating money from your budget into it. That reserve should now move towards your health. That is, making sure your health insurance is up to par and that you are covered in case sickness strikes; eating healthier products (i.e. increasing your groceries budget to allow purchasing better quality food); getting a gym subscription (in normal times) etc.
Why health you may ask? Because while your financial resources are limited you will be in panic mode and therefore, you will neglect your health, which would lead to higher costs in the future (which can deplete your emergency fund and put you back where you started). You want to break the cycle.
So, to recap: once your minimum living expenses are fully budgeted for, allocate the remaining income (5-10%) to the debt repayment >once that is gone build up that emergency fund > once that is fully funded you focus on your health and wellbeing by eating and living healthier.
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The information contained herein is for informational purposes only. Nothing herein shall be construed to be financial, legal or tax advice. The content of this article reflects solely the opinions and beliefs of the author, who is not a licensed financial advisor or registered investment advisor. The author strongly recommends that you perform your own independent research and/or speak with a qualified professional before making any financial decisions.