5 Types of Budgets That You Can Emulate as a New Retail Investor

5 Types of Budgets That You Can Emulate as a New Retail Investor
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“Start investing when you’re still young or you’ll regret it” is a common phrase we often hear. Many people, be it financial advisors, investors, friends and family may attest to this advice as a universal truth. One method that you can utilize is through the different types of budgets so that you can start keeping money away for future investing purposes.

The main reason why it’s important to start investing while young is so investors can take advantage of the compounding effects of investing. Being exposed to investing from an early age will also benefit young investors who are able to soak up knowledge easier as it tends to be easier to absorb knowledge in your twenties or thirties.

If you are already motivated to start investing from a younger age, there is probably only one big problem that you may face next: lack of funds due to lack of savings. 

Budgeting is an important factor as it allows you to plan for future investments. Most investors want their investments to earn passive income or dividends for them. A large sum of money is required to ensure a steady and significant amount of money in dividends. The higher the desired dividend, the higher the value of investments required, the more money will be needed to go towards investing.

The best way to accumulate money and start investing is by taking charge of your finances and being more conscious of your spending. 

If you find yourself unable to accumulate much savings to even start investing, then you should try to budget your expenses. This article is written under the assumption that you have already saved up for emergency funds, and you are now budgeting to put money away for your first investment. Otherwise, you should put money away for emergency funds first, ideally 6 months’ worth of expenses.

Here are the few types of budgets that you try out:

1) Spending Budget

This type of budget is what you would typically think about when the word ‘budget’ is mentioned. That is: deduct your expenses from your net income and save the remainder. 

Check your net income by searching your income tax bracket and calculate how much money you need to pay when you submit your tax returns, after taxes are deducted, make sure to also exclude your EPF/SOCSO contributions and any recurring interest payments. 

As you may know, Malaysia follows a graduated tax rate structure for personal income tax, starting at 0% (on the first RM5,000) to a maximum of 30% on chargeable income exceeding RM2,000,000 with effect from YA 2020. However, you are only required to file for taxes if you earn more than RM34,000 per annum after EPF contributions.

For more information, check out Inland Revenue Board Of Malaysia’s website on the current income tax rates here. Additionally, here’s a tax calculator for an easier method to estimate your tax rate and EPF/SOCSO contributions.

Make sure to jot down net income, and keep track of your monthly expenses such as rent, utility bills, groceries, and other discretionary spendings in a spreadsheet. 

By the end of the month, you should be able to see how much money you have left over, and this amount then goes into your savings. However, it is important to create a budgeting goal (ie: how much do you want to save each month) and work towards it. Otherwise, there would be no reason to conduct this exercise.

This type of budget is important for anyone who has never tried budgeting before, as it can help you be more mindful of your expenses to fulfill your savings goal and eventually, save enough to start investing. As such, the spending budget is also known as a spending plan, as it serves mainly to get you started and to adjust your spending habits.

As a new retail investor, this budget serves the purpose of ensuring you are mindful about how you spend and what you spend on, and help you decide how much to put away for future investments.

2) Split The Budgets 50/30/20

This is a popular budgeting method, where 50% of your net income should go towards ‘needs’ expenses, 30% goes towards ‘wants’ expenses, and 20% towards savings and debt repayments.

What are your ‘needs’ expenses exactly? Well, it is expenses that correlates to your essential needs, such as rent payment, bill payment, groceries, toiletries etc that you cannot live without. Your ‘wants’ expenses are non-essential spending, such as dining at restaurants, entertainment expenses, holidays etc.

The remaining 20% of your income is generally allocated to savings and debt or loan repayment for a car or house loan. Balance out the 20% between debt and savings, and see what is the percentage remaining after debt repayments. Try starting out with an initial savings percentage, for example: 9% for savings, and then, after tracking and measuring your expenses for a month, work out which non-essential expenses to cut and adjust the budgeting ratio for the following month so that you can contribute more money towards investing.

The 50/30/20 budgeting method may be more suitable for those who are more frugal in nature, because that would mean having leftover money from your 30% allocation for the ‘wants’ category. This leftover money can then be contributed towards savings.

For example: after one month of utilising the 50/30/20 budgeting method and discovering that there is leftover money amounting to 3% of your initial 30% allocation for the ‘wants’ expenses. This 3% can be contributed to your savings and debt repayment category, which increases the contribution to 23%. Furthermore, you might even want to consider making this change permanent and turning your budget into 50/27/23 ratio instead.

On the other hand, if you tend to overspend, or if the allocated percentage does not fit into your current expenses, then you will have to make necessary changes to the 50/30/20 budget. You may have a high monthly rental that makes the 50% allocation on ‘needs’ expenses impossible to achieve or an ongoing car repayment that is impossible to fit into the 20% savings and debt repayment category.

For the following month, you will have to make changes to this budgeting method. The easiest way will be to slowly cut down on ‘wants’ expenses rather than ‘needs’ expenses. After you have successfully cut down expenses in the desired category, the additional money can then be funneled into your savings category so that an ideal percentage for your savings can be achieved. A healthy savings percentage means that you can achieve your investing goals as soon as possible.

Regardless of whether you can stick to the 50/30/20 ratio or if you need to make your own adjustments, try to slowly increase the savings percentage within your budget so that you can eventually save up enough to invest.

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3) Pay Yourself First Strategy

Just as the name implies, this method of budgeting puts emphasis on saving goals, and it is the opposite of the spending first method. 

As usual, calculate your net income, and then allocate a portion of your money towards saving for investments, and then use the remaining amount of money to pay for your monthly expenses. 

In order to do this, you need to already have a list of your monthly expenses. Otherwise, you might end up paying yourself too generously, aka putting too much money for safekeeping. This will result in an insufficient amount to pay for bills, groceries and transport.

Hence, this type of strategy should only be used when: you have a stable income each month, your expenditure is the same as last month, or have some extra money tucked away when unforeseen expenses pop up, such as: medical bills, car repairs, house repairs etc.

The pay yourself first budgeting strategy is unique in the sense that it makes you feel good about yourself when you are controlling your expenses. 

Think about your payday and how it makes you feel to have money deposited into your account at the very end of the month. The Pay Yourself First strategy operates on the same principle: you put aside savings money first, and spend the rest.

Better yet, have another bank account especially for your saving goal of making an investment, and automatically have a specified amount of money transferred into this account from your main account on your payday. There are a few options available: by setting a recurring payment or transfer or by setting up standing instructions through your online banking account at a specified date and duration. Then, you can slowly watch as this bank account gradually accumulates more and more money and this can be a very good motivator for you to keep saving your money.

4) Spending Ceiling

The spending ceiling budgeting method is a budgeting method inspired from this blog post. This budgeting method is very helpful for those who do not like to monitor and keep track of their expenses and the different expense categories (‘needs’ expenses, ‘wants’ expenses, debt and savings). 

Find out what are your average monthly expenses, and set your spending ceiling at about 10% extra as a buffer just in case you overspend in that month. For example, you find out that your average monthly expenses are RM3,550 each month, add 10% extra on top of that so RM3,905 will be your spending ceiling. However, you should try to keep your expenses to RM3,550 each month and a maximum of RM3,905. You are not allowed to spend any more money beyond your spending ceiling and any remaining money then goes into your savings.

However, this method of budgeting will give your investing goal some slight uncertainty, as the remaining amount that goes into this goal tends to fluctuate. Having a spending ceiling does not mean that you must spend until the spending ceiling is reached. Instead, spend modestly and there should be some extra money left over that you can contribute to your investing goal, which may be hard to predict.

On the other hand, this method is much more manageable and easy to use if you tend to have a lot of small expenses and find it a hassle to track all your expenses. Rather than taking your time to track each and every expense, the spending ceiling method means only keeping track of the spending ceiling amount and how much more money are you allowed to spend before the spending ceiling is reached.

5) The Cash Envelope System

The cash envelope system is more suitable for those who prefer to handle physical cash over credit/debit cards and any form of online or digital payments. 

This type of strategy requires you to categorise your expenses into different categories such as rent, bills, household items, groceries, dining out, clothing etc. However, you will need to already know your expenses, i.e.: how much to allocate to each category such as RM 2,000 for rent, RM 500 for bills (water, electricity, phone, Wi-Fi etc.), RM600 for groceries and so on. Then, cash out all your money for your monthly expenses, and place them into envelopes with its corresponding categories.

This system requires you to only spend what is allocated within a category (e.g.: dining out), and when the envelope is empty, resist the urge to ‘replace’ the money from other categories, otherwise it will cause a shortage of cash in that other category as well.

Being able to physically handle your money, rather than through online banking accounts or cards, can help you to have a better grasp of spending habits and it might help you control your impulses better. Not having enough money in a cash envelope category means no more spending in that category. If you have spent all your money in the entertainment category, then you will need to wait until the following month for all entertainment-related expenses.

The downside of this type of budget is that you will need to cash out your salary each month to pay for your expenses, and some expense categories, such as rent and bills are best paid through credit/debit card or through online payments. 

If you want to make the cash envelope system work, it is best if you pay your rent and bills as usual, but make necessary notes on the envelope to indicate where the money has gone. Another option is to try out different budgeting apps on your phone, so that rather than withdrawing money every month for expenses, you can keep track of your virtual envelopes instead.

By utilising this type of budget, you can save up money through allocating an envelope for savings (determine a suitable amount each month), and at the end of the month, see if there is any money leftover in any of the envelopes, and put the remainder into your savings envelope. This method may take time, especially if you tend to overspend, but this system can help give you the feeling of accountability that you need to get up and work up and accumulate savings for future investments.

The Bottom Line

These 5 budgeting methods are just a few of the most popular budgeting methods that we could find from our research. 

There are many different budgeting methods out there that will suit different people. Give them a try, and find out which type fits your lifestyle best. However, do keep in mind that all these budgets require you to have good self-discipline.

Sure, there are times where you may have to spend beyond what you planned for. Maybe you faced some kind of emergency that requires a huge sum of money, like medical expenses or car or house repairs, so having an emergency fund ready is really crucial to ensure that your quality of life don’t get affected by these emergencies.

By committing to a budget and changing your spending behaviour, becoming an investor is just a step away, and it is up to you to take the first step.

Read more about 4 Ways Islam Teaches Us To Manage Money Wisely

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