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|
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.
Monthly Net Income – Monthly 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.
|1 month||1 * ₱20,000||₱20,000|
|3 months||3 * ₱20,000||₱60,000|
|6 months||6 * ₱20,000||₱120,000|
|9 months||9 * ₱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.
If you do not have debts, you can allot the excess ₱10,000 to building your Emergency Fund.
Monthly Net Income – Monthly 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.
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.
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.