The Art of Budgeting: Financial Wisdom from The Economic Man

Budgeting. Arguably the skill when it comes to personal finance. It is the process of planning and managing your income and expenses, and allocating your money to different categories, such as essentials, wants, and savings. Budgeting helps you achieve your financial goals, both short-term and long-term, and it will improve your financial and mental health in the process.

But budgeting is not just about numbers and calculations. It is also about making smart and strategic decisions, considering the opportunity costs and trade-offs of each choice, and optimising your spending to maximise your utility. It is as much a science as it is an art, so it requires a certain set of values on top of the “technical” knowledge that comes with it. In this article, we will explore the art of budgeting… The Economic Way.

We will learn how to apply the economic principles and concepts that guide The Economic Man’s budgeting and financial decision-making, and how to adopt his mindset and strategies to our own personal finance situations. We will also provide some practical tips and examples on how to create and follow a budget, how to make smart financial decisions, how to save and invest for the future, and how to evaluate and celebrate our budgeting success. By the end of this article, you will have a better understanding of the art of budgeting, and you will be empowered to take control of your financial future. Let’s get right into it!

The Economic Approach to Budgeting

Budgeting is the foundation of financial health. It helps you manage your money effectively, and it allows you to align your spending with your values and priorities. Budgeting also helps you avoid or reduce debt, build savings, and prepare for emergencies or unexpected expenses.

But what exactly is this “budgeting” thing we’re talking about, and how does it work? Budgeting is the process of creating a plan for your income and expenses, and tracking and adjusting your spending accordingly. A budget is a tool that helps you allocate your money to different categories, such as essentials, wants, and savings, based on your financial goals and needs.

Budgeting is also a way of applying economic principles and concepts to your personal finance situation. Money is a scarce resource, and budgeting is one of the ways to optimise its use and allocation. Here are some of the economic principles and concepts that are relevant to budgeting:

• Resource allocation is the process of assigning or distributing resources to different uses or purposes. In budgeting, resource allocation refers to how you divide your income among different expense categories, such as essentials, wants, and savings.
• Optimisation is the process of finding the best or most efficient solution or outcome for a given problem or objective. In budgeting, optimisation refers to how you maximise your utility or satisfaction from your spending, given your income and preferences.
• Utility is the measure of satisfaction or happiness that a person derives from consuming a good or service. In budgeting, utility refers to how you value and enjoy your spending, and how it contributes to your well-being and happiness.

By applying these economic principles and concepts to budgeting, you can create and follow a budget that suits your financial situation and goals, and that maximises your utility and satisfaction. Remember: knowledge is power. The Economic Man is all about rational choices, and knowledge is the best way to make an informed choice.

Creating a Strategic Budgeting Plan: The Roadmap to Success

Setting financial goals is the first and most important step in creating a strategic budgeting plan. Financial goals are the specific and measurable objectives that you want to achieve with your money, such as saving for a holiday, paying off debt, or buying a car. These goals will help you define your purpose and direction for budgeting, and they can motivate you to stay on track and monitor your progress.

But how do you set financial goals that are realistic and achievable, and that align with The Economic Man’s mindset? You should take a look at my article on goal setting, as it has some nice examples and resources that you can apply to your finances. Go read it if you haven’t done so already! 🙂

Once you have all your goals clear and ready to be worked on, it is time to allocate your resources. Resource allocation is the second step in creating a strategic budgeting plan. We are talking assigning or distributing your income to different expense categories, such as essentials, wants, and savings, based on your financial circumstances, goals and needs. Allocating resources helps you optimise your spending and maximise your utility or satisfaction.

But how do you allocate your resources effectively and efficiently, and how do you align your spending with your values and priorities? One way is to use the 50-20-30 rule, which is a simple and popular budgeting method that helps you allocate your income to three main categories: 50% for essentials, 20% for savings, and 30% for wants. Essentials are the expenses that are necessary for your survival and well-being, such as rent, food, utilities, and transportation. Savings are the expenses that are related to your long-term financial goals, such as retirement, education, or debt repayment. Wants are the expenses that are discretionary and optional, such as entertainment, hobbies, or travel.

Here are some examples of how to apply the 50-20-30 rule to your budgeting plan, and how it relates to The Economic Man’s mindset:

• 50% for essentials: This category covers the expenses that are necessary for your survival and well-being, such as rent/mortgage, food, utilities, and transportation. You should keep your spending within a reasonable limit based on your income and your evaluation of  what an “essential” expense is. You should be realistic on this one, and determine what makes an expense “essential” as opposed to “very convenient”. Essentials should be the last thing to cut your spending on, especially after filtering them out and optimising them (maybe a cheaper phone plan, some off-brand foods or a more rational spending on utilities).
• 20% for savings: This category covers the expenses that are related to your long-term financial goals, such as retirement, education, or debt repayment. You should always allocate some income to this category, and try to save or invest that amount every month. This category helps you grow your wealth and achieve your financial independence. Sacrificing today’s pleasure for a better tomorrow is a very Economic approach to life, but don’t overdo it if that means you’ll live an unhappy life now 🙂
• 30% for wants: This category covers the expenses that are discretionary and optional, such as entertainment, hobbies, or travel. Things that bring you joy and happiness should always be there, and they can act as short-term rewards for your long-term financial plan. However, this should be the first part of your spending to cut down on if things start going south. Sacrificing your future well-being for instant gratification and happiness might sound good, but that behaviour can often come as a result of stress and worry.

The 50-30-20 rule can be adjusted based on your preferences and your income. If your income is on the lower end of the spectrum, essentials will probably take up a bigger percentage of your paycheck, and you’ll have to sacrifice some of your short-term “wants”, making it look more like a 70-20-10. As you start making more money, you may reward yourself with more “wants” or start investing a bigger chunk of your income, as long as you don’t fall into the “lifestyle creep” and start turning “wants” into “essentials”!

Economic Strategies for Effective Budgeting

Tracking expenses is the third step in creating a strategic budgeting plan. Tracking expenses is the process of recording and reviewing your income and expenses, and comparing them to your budget. This process helps you stay on budget, and it also helps you identify and correct any discrepancies or errors in your spending.

But how can you track your expenses accurately and consistently, and how can you measure your budgeting performance and results? There are plenty of tools and techniques that help you track your expenses effectively, such as budgeting apps or spreadsheets. Budgeting apps are third-party software applications that help you create and manage your budget, and that automatically track and categorise your income and expenses. They usually come with fancy graphs, presets and quality-of-life features that make it intuitive to get started. However, they are not 100% customisable, and they may not work if you have some very specific expenses or streams of income. Spreadsheets, on the other hand, are a sandbox. They require a lot of preparation, technical knowledge and customisation, but you can make your very own spreadsheet with as many nuances, functions and charts as you need.

By using tools and techniques that help you track your expenses effectively, you can monitor your progress, see what you’re doing right and what you can improve on. My advice is that you don’t get too lost in checking, comparing and trying all the tools and spreadsheets available. It is better to just get started and improve with time.

Adjusting Strategies: Flexibility in Financial Planning

Adjusting strategies is the next step in creating and maintaining a strategic budgeting plan. It is the process of modifying or changing your budgeting plan or behaviour, in response to changing circumstances, unexpected expenses or poor planning. But how do you adjust your strategies effectively and efficiently, and how do you adapt to the changing economic conditions and situations? The answer is: by using the economic principles and concepts that guide The Economic Man’s budgeting and financial decision-making, and applying them to your own personal finance situation. These guiding principles can help you evaluate and compare different financial alternatives or options, and to weigh the costs and benefits of each choice. Some of them are:

• Marginal analysis: This is the process of comparing the additional or incremental benefits and costs of a choice or action. When applied to personal finance, marginal analysis refers to how you evaluate and compare the impact of a change in your income or expenses on your budget and utility. For example, if you receive a bonus or a raise, you can use marginal analysis to decide how to allocate the extra income to your expense categories, such as essentials, wants, and savings. You can also use marginal analysis to decide how to adjust your spending if you face a cut or a loss in your income, such as due to a layoff or a medical emergency. How can you maximise your utility when more money comes in? How can you keep it as high as possible when things don’t go as expected? These are the questions that you should ask yourself if you want to apply this concept.
• Risk-return trade-off: The higher the potential return of an investment, the higher the risk involved, and vice versa. In budgeting, risk-return trade-off refers to how you balance your savings and investments between different vehicles, such as bank accounts, stocks, bonds, or mutual funds, based on your risk tolerance and return expectations. If you are a risk-averse investor, you may prefer to save your money in a bank account that offers a low but guaranteed return. If you are younger, or just willing to “risk it for the biscuit”, you may prefer to invest your money in stocks that offer a high but uncertain return.
• Time value of money: Money available today is worth more than the same amount of money in the future, due to its potential earning capacity. In budgeting, time value of money refers to how you value and compare your present and future income and expenses, and how you account for the effects of inflation and interest rates. For example, if you have a debt that charges a high interest rate, you may want to pay it off as soon as possible, as the longer you delay, the more you will end up paying. If you have a savings goal that requires a large amount of money, you may want to start saving as early as possible, as the longer you save, the more you will earn from compound interest.

By using the economic principles and concepts that guide The Economic Man’s budgeting and financial decision-making, you can adjust your strategies effectively and efficiently, and you can adapt to the changing economic conditions and situations.