Why having a Monthly Budget is Required for Financial Freedom

Everybody wants to achieve financial freedom – free from debt, financially secured, established a healthy relationship with finances and to live the life that you want. Do you want to achieve financial freedom but don’t know where to start? The answer actually lies with how you budget and set aside money for expected expenses or what we call Monthly Budget.

For this post Monthly Budget means Cost of Living per Month. This includes, food, rental, bills, insurance, transportation, etc. Does not include payment for debts or money you put in investments.

To easier understand the concepts below, we will assume that we have the following.

Monthly Net Income₱30,000
Monthly Budget₱20,000

It makes it easier to know how much money you can allot to pay your debts

If you are in debt, your second highest priority is to pay your debts.

First priority is to keep yourself alive. The monthly budget of ₱20,000 is the “Keep yourself alive amount”.

Keeping yourself alive is non-negotiable. It will be harder to work if you are hungry. It will be harder to recharge when you do not have a shelter to sleep into. In short, it will be harder to earn an income when you cannot provide for your basic need.

Then we can compute that the monthly amount that you can allot to pay your debts is ₱10,000.

Formula:

Monthly Net IncomeMonthly Budget = Debt Payment Amount

₱30,000 – ₱20,000 = ₱10,000

You can however, try to negotiate with yourself to lower your monthly budget by cutting unnecessary expenses like Starbucks coffee, not eating snacks or move to a cheaper apartment. When you cut your expenses down by even the smallest amount like ₱100, it makes you a day closer to being free from debts.


It makes the target Emergency Fund amount easier to compute

An Emergency Fund is important for us who does Personal Finance. Its the fund that we will use during emergencies such as the lose of our primary income.

In Personal Finance you need to build an Emergency Fund that is around 6 months to 1 year of your monthly expenses.

How much is your 6 months of expenses? How much is 1 years worth of monthly expenses?

If you do not have a monthly budget, you will not be able to answer the above questions.

What if you have a monthly budget of ₱20,000. You can easily compute your target goals for your Emergency Fund.

DurationComputationTarget Amount
1 month1 * ₱20,000₱20,000
3 months3 * ₱20,000₱60,000
6 months6 * ₱20,000₱120,000
9 months9 * ₱20,000₱180,000
12 months (1 year)12 * ₱20,000₱240,000

You will know where you are on building your Emergency Fund and you can confidently say that you are making progress in your Financial Freedom journey.

Example computation:

If you do not have debts, you can allot the excess ₱10,000 to building your Emergency Fund.

Monthly Net IncomeMonthly Budget = Amount for Emergency Fund

₱30,000 – ₱20,000 = ₱10,000

If this is your first time adding funds to your Emergency Fund then you are 4% closer to achieving 1 years worth of emergency fund.


It shows the Line between Needs and Wants Clearer

What if we get an additional income like a bonus or income from side projects? Let us say net 13th month salary amounting to ₱30,000!

We quickly make a list of things that we want to buy. Before we click Add to Cart or Checkout, we ask the question “Is this a need or a want?”

If you have a monthly budget, you can say “I have paid for my apartment rental. I have budget for our daily meals. Insurance is paid for the month. Water, electricity, Netflix and internet are already paid for the month. My needs are already covered by the monthly budget of ₱20,000. Therefore, the things on my to buy list are wants.”

Now that we know that we can live without buying the items, we can allot the additional ₱30,000 to paying off debts or investing it. That is more than a month’s worth closer to being debt free or closer to becoming Financially Free.


It makes the Target Amount to reach Financial Freedom easier to compute

Have you heard of the 4% Rule to achieve Financial Freedom?

To explain it in simple terms, let us say that your investments earns an interest of 4% per year.

The goal is to only spend the interest, and never touch the capital so that it will continue to earn the 4% interest yearly.

If you reach a capital amount where it earns 4% per year that is equal to your yearly expenses then you will not run out of funds.

So how much should that capital be?

Formula to compute for your yearly budget

Yearly Budget = Monthly Budget * 12 months

The Yearly Budget is equivalent to 4% interest per year.

Formula to compute the Target Capital for Financial Freedom

Target Capital = Yearly Budget / 4%

In our example of having a ₱20,000 monthly budget the computation can be seen below.

Yearly Budget = ₱20,000 * 12 months

Yearly Budget = ₱240,000

Target Capital = ₱240,000 / 4%

Target Capital = ₱6,000,000

If you have ₱6,000,000 worth of investments that earns 4% interest per year then your monthly budget of ₱20,000 will be covered even if you do not work.

Since you no longer need to work to survive, anything that you earn outside of your investments is considered additional funds. You can spend it on wants or you can also add it to your investment capital so that your yearly budget can increase. This is what it means to be Financially Free.

If you do not have a monthly budget it would be hard to compute the Target Capital to achieving Financial Freedom.


Conclusion

The journey to Financial Freedom is not as easy as how people shows it to be, many times its complicated. One of the things that made it easier for me was when my wife and I decided that we will be sticking to a monthly budget. All other things became easier to imagine achieving after that.

For me, the first step to your journey to Personal Finance is creating a monthly budget for your daily needs.


Note

The truth is Monthly Budget changes thru time and circumstances. It can be affected by getting married and having children. Or something not easily noticeable such as inflation.

It is important to recheck what your Monthly Budget at least every 3 months.

There is debate whether the 4% Rule for Financial Freedom is enough. To simplify things, stick to the 4% Rule. We will write something more in depth about this on a different post and we will apply it on a Philippine setting.


If you ask yourself how much is your Monthly Budget to cover your needs, can you answer directly with a number? What are your struggles in computing your Monthly Budget? Let me know in the comments below.

Emergency Fund: Why It’s Important & How To Save Up For It

We always hear about Emergency Fund (EF) when we start to manage our finances. Financial advisers advises it, family & friends with good finance practices encourages – but what is an emergency fund? This will serve a financial safety net for those unexpected expenses. It is money stash aside to cover the family’s monthly living expenses and basic needs when you are unable to work or earn.

Continue reading Emergency Fund: Why It’s Important & How To Save Up For It

How to Start Saving Money for the Family

While saving money is second nature to some people, not everyone is good at keeping their money in their pockets. However, not everyone who are good with managing their money started off smoothly. In fact most have struggled and failed multiple times before finally gotten the hang of handling their finances well. Here are ways to prepare yourself and to start saving your money:

ASK YOURSELF THE DIFFICULT QUESTIONS

One of the effective ways to address a difficult situation is to confront it. You can confront your problem by asking the difficult questions and allowing yourself to answer these honestly:

  • How much do I earn? Is it enough?
  • Am I earning less or spending too much?
  • Where is my money going?
  • Why do I feel that my money is never enough?
  • How do I need to lessen my expenses?
  • What if something happens to me or my family?
  • Where do I get the money for emergency situations?
  • What will happen to my children if something happens to us (parents)?
  • Do I have enough funds when I get old?
  • Where will I get the money when I/family member is terminally-ill?
  • Will my future self and family be financially secured?

This list of questions goes on and the answers will come quite shocking. Hence the very reason why people do not ask these difficult questions to themselves. But this will show you the real financial situation you are in. And will give you a glimpse of what it might be for you and your family in the future.

HOW MUCH ARE YOU EARNING

Are you living below, within or above your means? It starts off with knowing how much money you have and how much you earn each month. Knowing how much you earn will help you see if the lifestyle you choose is financially sound for you or if it is time that you need a bigger stream of income.

List all the income streams you have: salary from work, income from a rental property, small business, side projects, etc. Make sure you know the rough average monthly income you have.

BUILD A BUDGET

Some people take budgeting the wrong way. Budgeting is to plan where to spend your money and allocate how much money you can spend on each.

The 50-20-30 Rule is an ideal way to help you build a budget by using three spending categories:

50 %
LIVING EXPENSES
20%
FINANCE GOALS
30%
FLEXIBLE SPENDING
Rent
Utility Bills
Groceries
Children’s Tuition
Commute to work
Etc.
Insurance/s
Mutual Funds
Investments
Etc.
Dine out budget
Clothing expenses
Etc.

– 50% : living expenses and essentials
– 20% : financial goals: savings, investments, and debt-reduction payments
– 30% : flexible spending which is everything you buy that you want but don’t necessarily need. 

SOURCE: Forbes | New in Budgeting? Why you should try the 50-20-30 rule

As per priority: Living Expenses > Finance Goals > Flexible Savings

Your first priority should be the current living expenses. This will give you the security that you have the money to pay the rent, bills and cover for food for the rest of the month. It should be followed by setting aside money for the future in different forms. And while flexible savings is also important (so that you will not feel choked and you get to enjoy some of your earned money) – it should be the lesser priority.

If you are spending above 50% of your income to living expenses – that may well mean that either of the two: 

  • You are living beyond what you can afford
  • Your income needs to grow more

WRITE DOWN WHERE YOU ARE ACTUALLY SPENDING YOUR MONEY

Sit down and list where your spend your money on. This is to keep track and give you an accurate picture of where you spend your money on.

The list should included the monthly rental/mortgage, utility bills, subscriptions, children’s tuition, commute to work expenses to afternoon snack or coffee dates with your friends. Categorise each these as Living Expenses, Finance Goals & Flexible Spending. 

Keeping list will makes it easy for you to see how you are spending your money. It will also allow you to work on areas where you can lessen your expenses or increase your income (sell baked goods, etc)

It might be difficult to achieve at first but this is, nonetheless, achievable.

LESSEN EXPENSES WHERE YOU CAN

Spending impulsively, reckless buying of whatever you think you need are some expenses that cut the bulk of. But there are also ways to curb your expenses in some practices that you already have but don’t know that you’re spending too much on.

  • Practice habits to lessen electricity/water bills. 
  • Prepare a thorough list every time you shop, and do not stray from it UNLESS it’s something that you NEED but forgot to write down. 
  • Buy cheaper alternatives/brands for food items, toiletries, detergents, etc. 
  • Grow your own food: tomatoes, siling labuyo, kangkong, calamansi, onions, herbs, carrots, potatoes, etc.
  • Cut off unnecessary subscriptions (Netflix, Spotify, the likes) if you are not even using it or simply can not afford to continue
  • Move to a cheaper/affordable rental – expensive at first but will pay off greatly in the next months/years.
  • Decline/Lessen social gatherings where you will spend either on commute, food or gifts.

GET THE FAMILY INVOLVED & BE ACCOUNTABLE

Involve everyone who will in some way be affected by this finance practice. Everyone should know and understand that you, as a family, are trying to keep a budget and curb the expenses. If it means switching to affordable food alternatives, eating out once a week/month instead for your usual, cooking food instead of ordering delivery, etc. Do not be afraid to let them know that this is a way to protect & provide.

Setting aside money is not just a practice you need to do to buy an expensive gadget or buy a home appliance, etc. It can also come in the forms of Savings that your future self and family can/will use, an Emergency Fund for the unforeseen situation or crisis, for Insurance Policies for protection and security, or on Investments so your money can earn and grow.