Financial Independence: Basic Budgeting

Introduction

In our last post, we introduced financial independence and how to achieve it. Remember, financial independence means having enough income to cover your expenses without relying on earned income from a job or other sources. Bringing up the question, how do you know how much income you need to cover your expenses? You can find the answer to this question through budgeting. Budgeting is the process of methodically determining your reoccurring income and expenses. The budgeting process includes setting limits on how much you spend and goals on how much you earn. 

Simple Budgeting

The budgeting process can be overwhelming at first, so it's best to start simple and add to it as needed. The very first thing is to determine your current state. How much are you currently spending?

Write down this number somewhere. You can do this on a yearly, monthly, or weekly basis. For most, monthly will be more convenient because it averages out the day-to-day yet allows for seasonal flexibility for the year. Now do the same thing for your income. How much are you making? Again, this can be yearly, monthly, or weekly but make sure that it matches the duration of your previous calculation. Now, subtracting your expenses from your income gives you your cash flow. Remember this term. Cashflow is the amount of money you are making over a duration. 

Income - Expenses = Cashflow

Budgeting Example

Let us practice with an example. Assume that you have three different credit cards that you use to spend so that you can utilize their rewards program. These credit cards have a majority of your expenses. So you log in to their specific websites and find a way to see the data for last year. So for the first card, you spent $10,467. For the second card, you spent $2,794; for the third card, you spent $4,376. Now you add them all up. 

$10,467+$2,794+$4,376 = $17,637. 

This number represents your yearly expense. Let us say that you earn $20,147 from dividends, salary, or social security after taxes. You get this information from your bank or your brokerage. 

What would be your cash flow? 

$20,147-$17,673 = $2,510.

This means that you are saving up $2,510 per year. That is great if you're saving up for a down payment for a house after ten years. But not so great if you are planning for a down payment for a home after two years. 

That's it. These numbers are all you need for your initial budget. These three numbers will tell you if you need to earn more, cut your expenses, or keep things the same. They will also tell you how much you need to be financially independent. Look for more information on this in future posts.

Advanced Budgeting

Now for slightly more advanced budgeting, you do the same thing but with categories for different types of spending and income. Some examples of categories of expenses could be:

• Auto (Gas, Repairs)
• Insurance
• Medical
• Groceries
• Fast Food and Restaurants
• Childcare

Examples of Income:

Salary, Dividends, Interest, Business, Side-hustle, etc.

You would repeat the same process as before but for each category. 

Example: 

Auto: $70

Insurance: $100

Groceries: $300

Total: $470

Using this example, you know you are spending the most on Groceries. If you can switch to cheaper brands or buy some things in bulk, there might be some savings. If you're still hungry and saving on groceries is not an option, you know to shop for cheaper Insurance because it's the next highest category. Do you see how this can help you if you aren't paying attention to where you spend your money monthly?

This process can help you better track your expenses over time AND help you make decisions on where to reduce them. For income, it can help you determine what is making you more money so you can focus your efforts there. 

The amount of detail that goes into your budgeting is up to you and varies based on your needs. Start simple and then iterate as your needs evolve.

Conclusion

Budgeting is a critical step to achieving financial independence. It can help you figure out how much income you need to be financially independent and what areas to focus on to reduce expenses. Now that you understand the basics of budgeting, you can start to apply it to your situation.

This blog post is for informational purposes only and is not intended to provide financial advice. All readers should consult a qualified financial professional before making any financial decisions. The author of this blog post makes no representations as to the accuracy, completeness, suitability, or validity of any information on this site and will not be liable for any errors, omissions, or any losses, injuries, or damages arising from its display or use.