Retirement planning – Budgeting (I)

We have spent the past few weeks trying to figure out how we can estimate what we may need in retirement. A common variable, which received different treatment in different models, is our projected monthly and annual spending in retirement. Consequently, coming up with a budget is crucial to the overall financial planning of our retirement, and that is what we will take up today.

What is a Budget? In our context, a budget will refer to an individual’s estimation of incomes, expenses and investments over a specified future period. Whilst a corporate budget would be drawn to align with corporate objectives, resources and strategy, a personal budget would be drawn taking into consideration earnings, other resources, obligations, age, personal requirements, lifestyle and aspirations, etc.

Purpose of Budgets: Budgets are drawn by individuals/households for many purposes such as to help:

Set and pursue short-term and long-term goals
Forecast, track and monitor spending
Build emergency fund and make retirement savings and investments easier
Achieve the required financial stability and independence
Help meet contractual obligations as they fall due
Provide monitoring and control capacity over finances and financial situation
Identify wastes to be eliminated and opportunities to be seized
Reduce financial stresses and improve mental health, etc.

Keeping track of our inflows and outflows and exactly what we are spending on and investing towards achieving various financial and non-financial goals is important to the overall scheme of everything else we are doing in life. Specifically for the person working towards retirement, budgeting will bring out the following:

Current sources of incomes
Current spending patterns
Future spending requirements
Savings and investment requirements to meet current and long-term needs, etc.

As I mentioned elsewhere earlier, we are largely, unfortunately, a people not inclined to drawing budgets and striving to live by them. We simply get inflows, spend and invest out of them, and roll over any surplus or deficits to the following month and continue on with our lives. This mindset and approach are unwise and suboptimal.

Why don’t we budget? Despite the many benefits of budgeting, there are several ‘reasons’ why people don’t take it seriously. Some people are somewhere around the two ends of an expense-to-income ratio spectrum: At one end are the people who can hardly meet their monthly expense needs. At the other end are people whose monthly expenses are infinitesimally small in comparison to their income. In the former case, the individuals might think a budget wouldn’t help and in the latter, the individuals might think it is unnecessary. Each is a type of error that should be avoided. Some other times, people think budgeting requires some Quantum Mechanics-type mathematics that they can’t handle. However, personal budgeting requires no more than junior secondary mathematics. Besides, there are computer applications that can do everything for you if you can make some input estimates. Yet again, sometimes individuals can feel secure about their jobs and think they don’t need to plan. But empirical observations will reveal that many jobs are not as secure as they may seem or used to be. Other times, some individuals believe a budget will only constrain them from ’enjoying themselves’. Perhaps. Purposely, budgets can bring out points and issues that you may need to defer gratification. Furthermore, some individuals think that their ‘simple’ life doesn’t need to be complicated by some periodic budgetary exercise. In reality, even ‘simple lives’ need budgetary discipline to be sustained over the long run!

Types of budgets: The basic details between corporate and personal budgets are in many ways similar. However, for individual retirement planning purposes, we can look at the following types of budgets:

Project Budgets/Problem-Solving Budgets: Project budgets are financial estimates that we make to carry out a particular project. This might, for instance, be for the completion of our residential building, which will involve making estimates of what we need to complete the project, where the funds will come from, over what timeframe we will have the funds and complete the project, etc. A project budget might also be for the purpose of starting a particular business in the future. Similar to project budgets are problem-solving budgets. These are budgets we draw to help us solve specific problems over some timeframe. For instance, we can have a budget to help us pay out our loans. This will involve identifying all debts, their amounts and carrying costs; where the repayment funds will be coming from and over what timeframe the exercise will be completed.
Master Budgets: Master Budgets are sometimes called Comprehensive or Planning Budgets. By whatever name we choose to call them, these budgets are comprehensive in detail and planning. For personal purposes, they are budgets that bring out revenue sources, our one-off and recurring expense requirements, our investment plans, etc. Typically, project and problem-solving budgets will be subsumed into a master budget. While the first two will normally be ‘short-‘ and ‘midterm’, the last will typically take a longer-term perspective on issues. The farming business we want to go into after retirement in fifteen years should begin to appear on our planning horizon. Similarly, our daughter’s wedding coming up in about two years should begin to be fully captured and planned for.

Another way budgets are categorised is in terms of timeframe (short- or long-term); amount (operational or capital) and static or flexible budgets. Regardless of their types, the objectives are always about maximising income generation and optimising the utilisation of resources.

Next week we will take up principles of personal budgeting and the budget process.