Why budgeting ? The prerequisite for increasing your savings rate

Maintaining a budget is obviously not a saving in itself. However, it is, in my opinion, the first thing to do for anyone who wants to increase their savings rate. It is imperative to have a clear and precise view of how your money is used.

Why we need to make budget ?

Indeed, it is essential to answer this question at first. As soon as I became interested in increasing my savings rate, all the different readings I did talked about budgeting. Personally, I had already made a small budget at the time when me and Mrs GP got engaged, because we had to know how much we had to contribute to our common account (household account) to pay for our various common expenses. It was a simple Excel table and we haven’t adapted it for years. But it was still a form of budget.

If you want to increase your savings rate, you need to be able to put more money in savings. To put more money aside, you need to know where you can save. And that’s not possible without an accurate and up-to-date budget. The budget will help you visualize your different categories of expenses and force you to think about all the potential expenses you may have in the month! Here are the chapters we will cover:

  • What is the best way to make a budget?
  • Create and maintain a map of your expenses -> visibility.
  • Do not spend money on anything.
  • Manage your capital from one place.
  • Manages budget overruns.
  • Optimize your expenses while being flexible.

What is the best way to make a budget?

In these times, I think it is essential to have a tool that is available at all times. An Excel sheet can work, but if you want to track your expenses on a daily basis, you need a tool that you can pull out of your pocket at any time. I recommend an application that is available on a smartphone. Here are the features I want:

  • Multi-platform (Android, IOS, Windows, Mac)
  • Online backups
  • Multi-budget / multi-person
  • Free or not too expensive
  • Easy to use
  • Flexible and adaptive

After doing several searches, the tool I recommend is called “YNAB“. YNAB stands for “You Need A Budget”. This tool is really amazing and on top of that, the support is very reactive if you have any questions. They also offer a whole video training support. Don’t get scared, it’s simple to use, but there are some basic concepts to understand and most importantly, you’ll really understand the philosophy behind this tool!

Personal experience with YNAB

As I write this post, I’ve been using YNAB fully for about 8 months now and I couldn’t live without it! This tool has really allowed me to list all of my spending categories and has given our family a clear and accurate view of our spending. We have really taken a pleasure in maintaining this budget, and it has changed the way we think before a purchase. Our reflex before buying something is to see if we have the budget for it! This extra step in our decision making process helps to avoid an overly emotional purchase. We really ask ourselves more frequently the following questions:

  • Do I really need this or is it just a desire?
  • Will this purchase improve my quality of life permanently or just temporarily?
  • Is this purchase redundant?

Of course, that’s the theory and in practice, in the rush of action, it’s not so easy to answer these questions, but we try to do it. Specifically, since using YNAB, I have increased my savings rate by about 30-40%. That may not sound like much, but over the long term, it’s a lot. We still have categories of expenses that we want to optimize such as my leased sports car. I’ll write another post about the leased sports car, but if I go through with this optimization, according to my estimates, it will allow me to save about CHF 400/month, or CHF 48,000 over 10 years, and that’s without counting the potential return if I were to invest these savings in the stock market.

Before, we were like everyone else and lived from salary to salary without worrying too much about our savings rate. Since our salaries allowed us a more than acceptable lifestyle, we spent as much as we wanted. We didn’t think too much about it, because we each contributed a little to a 3a pillar and had permanent transfers with small amounts to savings accounts. From month to month, we knew we weren’t spending more than we earned, but that was the end of it. While this seems like a traditional way of life for most people, I was not happy with it. With YNAB, at the beginning of each month, I know exactly how I’m going to make my money work! We really got into a planned spending mode instead of a random, run of the mill mode.

I understand that some people may not like this way of doing things, but it works for us and motivates us to make these efforts to think about our savings. Once we adopt this way of operating, it is really possible to make plans for the future. I’m talking about major plans such as buying a house, a vacation property or an investment property, or even more distant and ambitious plans such as financial independence or (very) early retirement.

In short, YNAB is a tool that allows me to have a clear and accurate view of all my assets in one place at all times and most importantly, it really helps me optimize my spending! I love it and I recommend it!

First steps with YNAB

I hope I motivated you enough with the previous chapter. If you are, you can test YNAB for free for 34 days! This will allow you to make your first budget and understand the finer points of the application. After this period, you will be invited to purchase the application. You will have the choice to pay per month or per year. I strongly advise you to take the annual plan for two reasons:

  • $59 annual savings ($84/year versus $11.99/month).
  • If you order it for one year, you will be much more motivated to make the effort to use the program.

The second reason is very important. In fact, at the beginning, you may be a little discouraged from using this application, because you may see it more as a constraint than a benefit. You have to hang on. Indeed, you will take quite some time to make your initial budget, namely :

  • Create your expense groups (contains one or more categories)
  • Create your expense categories
  • Determine the amounts needed in each category.
  • Find out the exact amounts of your obligations (subscriptions, insurance, taxes, etc.).
  • Understand and create Goals.

And the first few times, it’s going to be a bit cyclical, as you’ll go through your spending categories a few times and adjust your goals. I personally made the mistake of not watching the “Get Started with YNAB” videos and I wasted a lot of time with that in the beginning. So I would advise you to really take the time to watch these videos to get started with YNAB.

The 4 basic rules

Although the application is very well designed and ergonomically very convenient, it cannot produce satisfactory results without you. It is important to understand 4 basic rules.

Rule 1 – Give Every Dollar a Job

For me, this is the most important rule. It orders you to give, for every Swiss franc you earn, a task to that franc. In concrete terms, you will have to put this money into your budget. What is the purpose of this money? The objective is that at the beginning of each month, you know exactly where and how your salary or other income will be used. This will allow you to stop spending money willy-nilly. 

Only you control your money! When you earn money, you have to prioritize how you are going to use it, what you are going to use it for. You must avoid leaving money without a specific purpose, because this will cause three problems: 

  • You’ll be tempted to use it for anything.
  • If you don’t use it and it stays in your bank account, it doesn’t work and doesn’t earn you money. In other words, you could have invested this extra money in the stock market or used it to fill up your favorite Pillar 3a.
  • If you don’t associate your money with categories, you may find yourself having to pay a bill (an obligation) without having the necessary cash, because you spent your money on a whim or on an emotional impulse.

To summarize, rule 1 advises you to:

  • Earn and receive money.
  • Give that money a priority (give them a job!).
  • Follow your plan rigorously and do not deviate from it.

Rule 2 – Embrace your true expenses

It’s important to plan for your future major expenses! Creating a real budget is not limited to creating a simplistic budget for the current month but it should also take into account future bills and expenses that you have to pay infrequently. A good example is your car insurance of 1’500.00 CHF that you pay once a year in October.

How do you plan this expense into your budget when it’s January 1? You just have to divide this big bill into small virtual monthly bills. In our example, you need to make sure you have 1’500.00 CHF by the end of October. You will divide CHF 1,500 by 10 (there are 10 months from January to October) and put CHF 150 in your budget each month in the “Car Insurance” category. Thanks to the Goals concept in YNAB, you will be able to easily ensure that you have the necessary amounts on the date you need them. This applies to non-monthly expenses, but also to more random or volatile expenses. Here are some examples: 

  • Birthday gifts.
  • Summer and winter holidays.
  • All kinds of insurance.
  • Service / Vehicle maintenance.
  • Your SBB pass, etc.

To summarize, rule 2 requires you to:

  • Identify large non-monthly expenses.
  • Create a goal to be filled every month (virtual invoice).
  • When the expense arrives, you just have to pay it without worrying, because you know that you have set this money aside for this specific expense on this specific date!

Rule 3 – Roll with the punches

Rule 3 is designed to help you understand the importance of flexibility in terms of budgeting. Your budget, even though most of it will be similar from month to month, will evolve every month and this is normal. Unexpected expenses, an oversight or an urgent need, all of these elements will force you to deal with overspending. 

When you find yourself over budget in a specific category, don’t panic or feel guilty, just react intelligently and adjust your budget. Every month, certain circumstances change and will change your plans and therefore your budget. This is totally normal. Don’t forget rule 1, you are the master of your money, so if you exceed the amount budgeted in one category, take that money in another category that you know or think you won’t use all of it this month.

Imagine that you have spent CHF 300 instead of the budgeted CHF 250 for fuel. The reason for this overrun is justified, because you had to take your car to go to Geneva 3 times for work. This is exceptional, but you had to do it. You therefore have an overrun of 50.00 CHF in the “fuel” category. On the other hand, you notice that you did not buy as many clothes as you had planned this month. You had a budget of 100.00 CHF for clothes, but you only bought a T-shirt for 25.00 CHF. You have CHF 75.00 left in the category “clothes” and you could “move” CHF 50.00 from this category to the category “petrol”. In the end, you did not spend more than your overall budget indicated, but you were just flexible and addressed an overspending in a smart way. 

Rule 4 – Age your Money

Finally, the last rule is an important indicator and motivator for me! The goal is to “age your money”. Every month you have one (or more) money coming in, but a lot of expenses. As you use YNAB, you will start months with categories that will have a money balance from the past month. To use the example of rule 3, you budgeted 100.00 CHF for clothes, you only spent 25.00 CHF and you “moved” 50.00 CHF to make up for an overspend on gas. Nevertheless, at the end of the month, the category “clothes” still has a credit of 25 CHF (100 – 25 – 50). Depending on the goal you have chosen, you will start the next month with a balance of 25.00 CHF for the clothing category. You will only have to take 75.00 CHF to reach your goal of 100.00 CHF for this category. These 25.- CHF of the past month have an “age” of at least 30 days. 

When you spend money from the past month, you don’t have to stress about it! The goal of this last rule is to try to spend as much of your 30+ day money as possible! It’s not going to happen overnight, but it’s really an asset if you can increase the age of your money. It will happen spontaneously, because if you follow the first 3 rules correctly, you will spend your money more conscientiously, consistently and above all in a way that has been planned, thought out and controlled. 

To resume :

  • Never spend more than you earn! (think of leasing and credit…)
  • The age of your money will increase rapidly!

Conclusion

Finally, the goal of all this is to spend less than you earn. Even if it is common in some countries like the United States to live constantly with credits, debts, etc., it is not the case in Switzerland. This is not the case in Switzerland. The only real and important debt that we often find in Switzerland is the mortgage debt and the leasing of a car. But beware, we see more and more purchase options that encourage buying with credit! It is more and more frequent to see purchases of TVs, sofas, etc. on credit or payable in several monthly installments. In the world of frugalism, minimalism and the FIRE movement, this practice should simply be banned! The goal being to increase your savings rate, you are not going to add debt to your capital.

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