Why are we so bad at organising our finance?
Do you have a tight rein on your finances? Are you the budgeting boss you want to be? Whether you’re a spreadsheet star colour-coding every purchase, or your money gets bored and wanders off halfway through even thinking about a household budget, this article has tips for you.
No one is born with money management skills, and we’re not taught them at school, either. So, rather than manage our money, we aspire to make as much money as possible. But financial security isn’t just about how much money you make, it’s also about how much you spend.
How we spend our money
On average, the largest percentage of household income goes towards paying housing costs (32%), transportation costs (16%), and food (12%). This is closely followed by personal insurance and pensions (11%), healthcare (9%), and entertainment (5%).
Of course, that doesn’t account for all our income, and there are ways you can readdress the balance. First, to rein in your unruly finances, you need to know where it comes from and where it goes.
What is mental accounting?
Behavioural economist Richard H. Thaler says that irrelevant criteria such as where an amount of money comes from (i.e. a tax rebate or a birthday gift) leads to us classifying the money as “free money”, and giving ourselves permission to waste it on non-essential purchases instead of, say, using it to pay towards an outstanding credit card debt. This can also work in reverse, where we perceive some money as “too important” to spend (e.g. savings for college or a new car) and hold onto it instead of paying off debt.
This thinking can also affect investment as well. The temptation for many investors is to divide assets between “safe” and “risky” portfolios, hoping that will offset any potential negative impact on the total investment.
Let’s face it, mental accounting is a pretty natural thing for your brain to do - a treat gives us a dopamine thrill and saving for a rainy day makes us feel responsible. But let’s get smart.
Discover where your money goes
As Maya Angelou said, “You can’t really know where you are going until you know where you have been.” Without tracking where your money is coming from - and most importantly, where it’s disappearing - you will never be able to budget effectively. At the end of each month, sit down and go through your bank statements and credit card bills, and cast an eye over your cash spending too. Keep a running spreadsheet of incomings and outgoings to build up an accurate picture. It’s easy to lose sight of small spending, interest payments, subscription services, and the daily Frappuccino.
Then it’s time for the dreaded B word: budgeting. Creating a spending plan means you’ll always have enough money for the things you need, plus more importantly – preach! – the things that you want. Following a budget will help you manage and keep out of debt.
5 tips to improve your money management
Learning how to invest in yourself (with a holiday fund or monthly entertainment budget) and your wealth (with regular payments on your own home or amassing a small stock portfolio) is a keystone of personal and financial well-being.
- Pay yourself first: when the money comes in, immediately set aside an amount for savings before you pay any bills.
- Curb unnecessary spending: kick gym memberships, magazine subscriptions and personal services you don’t benefit from. Can you save on the cleaner and do it yourself, or grab the bucket and sponge instead of heading to the car wash?
- Watch for “lifestyle creep”: do you really need the Rolls-Royce, the Hilton hotel stays, or another Louis Vuitton handbag?
- Invest and protect: avoid forking out to repair your new iPhone 12 that you’ve already dropped (twice!). Instead, invest in home, car and life insurance and reduce the risk of a hit to your finances that can start a debt spiral.
- Rebalance: aim to put aside around a third of your income for savings, a third on mortgage or rent, and the remaining third for utilities, food, transport, tax, and clothing. What’s left is disposable income that you can spend on whatever you like!