On Budgeting

It’s been a little over seven years since I first started my full time job. It was also the time of COVID, and I found myself holed up in my room reading up a lot of self-help books. One of the books I read was I Will Teach You to Be Rich by Ramit Sethi which was when I was first introduced to the concept of budgeting. I wasn’t immediately drawn to it but I read more about it, and agreed to try it out for one week. That one week became a month, then a year, and then 7 years, and counting.

So it’s been roughly 7 years that I’ve been budgeting; for the first year, I tried out various apps and tools. I downloaded and created multiple spreadsheet templates to find the one that suited my needs. And in May 2020, I came across YNAB (You Need a Budget), and found that it offered what I needed in a budgeting app. It uses a method of budgeting called Zero-Based Budgeting (ZBB). And the idea is to give every dollar of yours a job. This job could be paying your utility bills, your insurance, investments, or your monthly app subscription. So every month, when inflow in the form of either your salary or business returns, lands in your account, you distribute each and every single penny across various categories/buckets. And once you do that, you don’t have any money “lying around” or any dollar/rupee without a purpose. If you’re interested in YNAB specifically, there’s a good book on it by its founder or find more information on its website.

As of today, I’ve tracked ~8500 transactions over the the past 6 years, that’s roughly 1400 transactions per year. People sometimes comment on the value of budgeting and sticking with it for so long. But the thing with budgeting is that its first order effects are intangible and hence easy to ignore. They’re not apparent until after you’ve stuck with it for some time. This threshold obviously is variable but in my opinion, it does exist. Many times in the past, I’ve made the mistake of reaching for tangible outcomes when talking about budgeting, such as having a log of transactions, being able to visualize my spending trends, etc. Those are all second-order benefits which I’ll talk about shortly. Budgeting, first and foremost, is about awareness. Simply being aware of my finances is extremely valuable in itself. Having a bird’s eye view of my budget, areas I spend on, my assets, my expenditure leaks, etc, have made me acutely aware of my finances in general.

The very act of budgeting–keeping track of all transactions you make–helps with awareness. With the advent of digital payment options such as UPI and Credit Cards, the weight of spending is disappearing. All you need to complete a transaction is to either tap your card or enter your PIN; the amount doesn’t come to mind for the second time, and before you know it, you’re down a couple thousand bucks by the end of the day, if not the week. Compare this with the traditional cash-heavy model of payments where you are conscious about the amount of money spent because the higher the amount the higher the denomination of notes, or the number of notes, or both. So making the same purchase with both cash and a card, the former is bound to make you more aware of how “heavy” the purchase was. Thankfully, I’ve found that manually entering transactions is the next best thing when it comes to feeling the weight of the transaction similar to if I were using cash. There’s also the added benefit of recognizing leaks in my budget, once I was required by the process to track each and every transaction across all my accounts, I quickly realized expenses which were not yielding any value or transactions I wasn’t even aware of that were on auto-pay, and was eventually able to cut them out.

Having a clear picture of my finances directly led to reduced anxiety and stress. A lot of this stress existed because I had little clarity on where my money went by the end of the month. This is also perhaps the provenance of the joke “I’ve no clue where my money went!”. But once I knew where my money was going month-on-month, and of course after fixing some of the issues, there was surprisingly very little to worry about. In the past, when I had no system, no framework, when I would deal with purchases on an ad-hoc basis, I used to stress about finances because I couldn’t possibly keep my entire budget in my mind. But once I started budgeting, all I had to do was to consult my budget for the month and I’ll have a clear answer to questions such as “Would I be able to travel in August?” or “Can I buy this?”. Note that I used the term “buy” instead of “afford” but that’s a different, more psychological discussion not suited for this essay. I can now spend guilt-free on a lot of things because I kept money aside in the past few months leading up to the purchase or travel. The corollary is that I’ve not stressed about my finances in the past 6 years and that’s primarily in part due to budgeting. Sure, there have been occasional hiccups and that’s fine as long as I’m able to optimize for at least the remaining 80%.

Before I talk about the second-order benefits, it’s imperative that I talk about how my personal finance system has evolved and matured over the years. For starters, ZBB has changed the way I think about purchases, big or small. Everything relies on me tracking each and every transaction that I do across all my accounts, and then I can simply consult the particular category before making any purchase. But this also means telling myself sometimes that no, I can’t afford an outing this month. Funnily enough, there’s a term for this in the community–YNAB Broke. It’s when you objectively do have money but you still can’t spend on a particular category because there’s simply not enough money left in that category for that month. So you wait for next month to refill that category and go about your business as usual.

On a more practical note, I spend roughly an hour on the 1st or 2nd of every month on what I call the “Budget Day”. This involves allocating my monthly inflow into various categories, reconciling the transactions between my banks and the app, updating investment numbers, and paying off debt, if any. Spending an hour on the budget every month is almost therapeutic; in that I can see how terrible last month was and how I should course correct. Or on good months, It gives me a chance to think ambitiously about my financial goals for the future.

Once I have funded all the categories that I could or want to that month, I’m technically set for that month. Now I could only spend the money available to me for that category, no more. It might seem a bit restrictive at first but you get used to it in no time. A few months in and I learnt about leaks in my budget and came across categories I really want to spend or splurge on. With that information, I could distribute the allocation to suit my wants and needs for the upcoming months. For example, I love to travel and I very quickly realized that I should be allocating more to the travel bucket and effectively reduce allocation towards eating-out/ordering-in categories, it’s a zero-sum game after all. So now, whenever I travel, I can freely (and responsibly!) spend the amount from that category because it’s meant to be spent on travel. There are no qualms about whether I’m spending too much or whether I have enough left for some emergency waiting right around the corner. For annual purchases or recurring purchases, I use what YNAB calls annual goals, which is essentially simple arithmetic that consists of dividing a one-time annual purchase in 12 monthly parts that you allocate to the category every month so that when the time rolls around for that purchase, the money is sitting right there. I use this extensively for insurance payments, annual subscriptions, and personal finance goals.

This all might seem a bit much, and clearly this is additional overhead that’s not desirable for many. It was, for me. But then I wanted to ensure this overhead doesn’t scale with time. In pursuit of this, I reduced the number of credit cards I used from 3-4 down to 1, effectively consolidating all my spendings on just one card. This made reconciling the transactions between my card and my budget much easier than reconciling 3-4 different cards every month. Additionally, I got my credit card statement’s date changed such that it overlaps with my Budget Day. Now, when I sit for Budget Day, my credit card statement is ready for the previous month so I can reconcile the statement with my budget then and there. This makes budgeting slightly less time consuming than it was. In the same vein, I also reduced the number of funds I invest into from ~6-7 down to 3, with the same goal of reducing overhead when I reconcile transactions between my budget and investment portfolio every month. Less is more.

Now finally coming to second-order benefits. The most obvious one is visualization. This is the reason why many people are attracted to budgeting. Those fancy line graphs, colorful pie charts. They are real! My favorite of these reports is the Net Worth report. I mostly use it every year to set personal finance goals (reach certain NW by the end of 20XY year). The NW graph also helps with positive reinforcement–you see the graph rising, and you want to see it continue to rise! The other graph that I quite frequently refer to is the monthly spending trends trend. It’s a histogram that shows how you’ve been spending your money over the past few months or years. For instance, when I moved to Delhi from Bangalore last year, my spending graph declined because a lot of the expenses I used to bear when I lived alone were simply gone now and so I could see that I was, in fact, saving slightly more money than before. I also routinely use this graph to filter out spends on subscriptions over months to see if a sneaky subscription has come up increasing my baseline spends on monthly subscription fees. There are many other graphs available but I don’t use them as much as I use the two I mentioned.

The other second-order benefit worth talking about is “lookbacks”. I’m not sure if this is a term but it’s loosely based upon TLBs. Lookbacks simply means a vast inventory of old logs and information that you can refer to at any point in the future to derive insights or value. They have been immensely helpful for me in recent times. Having a vast inventory of transactions where I have noted down each and every spend and purchase, has come in handy when I want to recall how much I paid for an item, let’s say 2 years back. This might sound minor but has helped me numerous times while I’m negotiating a price for something. For instance, when I was purchasing a new battery for my car that I had replaced two years back from the same vendor, I was able to quote him the old price for the same battery and was able to secure a small discount which would’ve been otherwise not possible, or if possible, it would’ve been too cumbersome for me to even try. Or negotiating the price for a gym membership fee by telling the guy at the reception that I’ve been paying X for the past Y years and perhaps it’s time for a loyalty discount? It’s a small but very satisfying win.

When I show how I budget to friends and family, they often dismiss it as too much overhead for an intangible return. And rightly so, personal finance is not the same for everyone, much like everything else in life. I have many friends who are financially doing very well and have not budgeted once in their lives. Which is to say, budgeting is not something that would magically make your financial hygiene better. It would expose it, sure and perhaps that’s exactly what some people need, but that’s about it. And once exposed, that’s when you need to put the effort in. By prioritizing spending, cutting back on superfluous purchases, planning months into the future. That’s when you start seeing noticeable results.