A Robust Personal Budgeting to Transform Your View of Money

You may be already to record personal budgeting. But recording doesn’t bring you towards your financial goals unless you budget towards them. Those goals include personal wealth and financial freedom.

I learned this robust way to prepare my personal budget too late. But since I started to use it, my financials have been moving towards my goals. In this post, I will walk you through the process so that you can benefit from it too.

Some contents require a bit of accounting knowledge, which you can learn from the posts below:

Nevertheless, I will try to make the concepts easy to understand.

Now let’s dive into the powerful personal budgeting tool to transform your new year!

In this post, you will read:

Set your financial goals
Understand where you are (through the accounting way)
Income strategies
Spending management
Personal budgeting
Reflection
Some inspirations to surely kick off the journey to financial freedom

1. Set your financial goals

If you do not know where you are heading to, you may not like where you end up with. A clear goal is the northern star of your judgement and behaviors. That is why setting goals should be the first step of the process.

In addition, I put goal setting before reviewing your finance because I know too well that reality could sometimes constrain your ambitions and potentials. Therefore, you should set your goals with minimal disruptions from concerns of your financial status.

If Elon Musk can build an innovative recyclable rocket from scratch, you should be able to reach your financial goals through learning and hard-work, don’t you think?

On the other hand, financial goals should be in numbers so that you can measure clearly. For example, my goal is to make one million dollar as my annual income.

You will laugh at me if you know my financial status when I set up this goal. But because I set this goal without limitation from the present situation, I conducted detail research to see what are the paths that will lead me there and am taking actions moving towards it.

I am still learning of course, but you can see that setting a clear goals without concerning the current financials turns you into action mode and makes you concentrate on what you should do – it makes you more likely to achieve your goals.

There could be intermediate goals. My first goal is not making one million, but to pay off my student loan within 3 years. Secondly, I like to diversify my income streams to more than 5 in 5 years. Per studies, the average millionaire has 7 streams of income.

So what are your financial goals so that you can live a happy and fulfilling life?

2. Understand where you are

Once you determine your financial goals, we will look at where you are today. Examining the financial position using a revised accounting balance sheet is a good practice. As balance sheet is exactly used to examine a company’s financial position and has another name “statement of financial position”.

We put the assets on the left column and loans on the right. The difference between your assets and loans is your net wealth. For example, for those graduated from university and have worked for several years, your financial position may look like this:

In the asset column we have cash balance, funds, pension balance, tax-benefit accounts, investment, and house.

Cash balance is the free cash on your hand that you can use for anything. Funds are also cash balance, but they are saved for particular purpose, for example, emergency fund, vacation fund etc..

Pensions and tax-benefit accounts balances are the amount you put into those accounts. I separate them from cash because you may not be able to use the balance today, but the amounts will become your income in the future.

Of course, your pensions and balance of tax-benefit accounts will be invested, but the investment in the financial position is from your after-tax money. For instance, if you have set aside $500 to your pension and receive $2000 from paycheck, then you invest $500 into a mutual fund. This $500 is the investment.

You can clearly see that the student loans are a huge burden and directly make your net wealth negative! If a company has such financial position, the company goes bankruptcy. So as we. My financial position in the beginning of the journey is very similar to this.

But if you have bought a house through mortgage, your financial position will be like:

Although your loans increase because of the mortgage, your assets also increase because of the market value of the house. Mortgage is backed by the real estate you own and thus is different from other loans that simply drag down your net wealth.

Just as the balance sheet of a company, this personal financial position kind of reveals immediately what is your biggest resource and biggest challenge.

If your financial goals include net wealth, now you can compare your present status with your goal and check what is the gap. Don’t be discouraged if the gap is too big. I will discuss many ways to gradually narrow the gap and make you closer to your goal.

3. Income strategies

There are simply 2 ways to increase your net wealth: increase your income and reduce your spending. This section we will focus on increasing your incomes.

3.1 Income category

The average millionaire has 7 streams of income. But how do we categorize the income streams?

A LinkedIn post categorizes into earned income, interest income, profit income, dividend income, rental income, royalty income, and capital gains. This categorization has a wide range and may help you to evaluate your income diversity in a big picture, but it will take year to diversify to gain those categories – this may discourage many.

Therefore, I prefer a simpler way: just count the ways you make income. For example, when you do not have too many assets accumulated, you may diversify your income by working on a side hustle and freelancing – both could be an earned income on top of your earned salaries.

You could have multiple earned incomes to diversify your income streams. And even not every millionaire has royalty or rental income as mentioned in the LinkedIn post.

3.2 Income leverage

After clarifying the income category and diversity, we can dig into the income strategies.

The essential of income is leverage. You leverage your resources and turn them into incomes. This is similar to the concept of an accounting ratio called return on asset (ROA).

But unlike a company, we as individuals may not have physical assets in the beginning unless you come from a loaded family that provides you the resources.

However, resources do not have to be physical assets. So what kind of resources we could leverage? I got the inspirations from Codie Sanchez, one of my favorite content creators: for average person, we could leverage time, expertise, audience, and money.

Time is a fair resource, same amount and same limit for everyone. We just need to make sure that we use this resource wisely. This is also the reason why earned income could reach a plateau, because earning those incomes consumes your time. Once your time is used up, your incomes upside is gone.

There are indeed millionaires who rely heavily on earned income – but this will be an extremely competitive and thus very tough road. How many executives are there in the companies that afford to pay such a high annual salary? Meanwhile, how many employees there who want to climb up the ladder? You can do the calculations.

I am not saying that earned incomes are bad. On the contrary, earned incomes are the first type of income that everyone can get after reaching legal working age. And by leveraging your time to earn salaries, you get an opportunity to gain expertise.

Expertise is the next-level resource, as leveraging expertise could bring you more diverse incomes. Firstly, it could increase your earned salaries. Secondly, it allows you to work on consulting or freelancing side hustle. Thirdly, it opens door for you to earn passive incomes – this will be discussed later.

Audience is a new resource to leverage in the digital age and is the main leverage of content creators and influencers. With sufficient audience base, they earn very decent incomes.

Lastly, money is not only the financial goals, but also the scarce resource to efficiently diversify our incomes. For instance, you can buy a company to earn extra dividends or scale up your own (horizontal mergers and acquisitions).

3.3 Income ideas

After learning income category and leverage, we now can systematically check various income ideas. There are so many people talking about all kinds of income ideas and you can easily search on Google YouTube.

My personal recommendation is to go to Codie’s 29 income ideas. Although Codie describes them as investment ideas, those ideas are also business ideas. The good thing about this list is that she combines the income ideas and the leverage, making selecting ideas so much easier.

If you do not want to go through the whole list, I have summarize it for you:

I recommend not selecting more than 3 ideas that consume time. If you are in the early years of your career, find a job or side hustle that help you build expertise or audience so that you can gradually diversify your incomes.

Last but not least, do note that, the important factor that you succeed in diversifying and thus increasing income is execution. Ideas are not so scarce, but the capability to execute the ideas is.

4. Spending management

Finishing strategizing the incomes, we move our focus to managing our spending side of the personal budgeting.

4.1 A convenient trap

When the economies go well, people like to spend on luxurious goods, such as cars, watches, bags, etc.. There is nothing wrong to enjoy luxurious goods especially when it is within your income range. But if you are a person who want to increase your net wealth, you need to be cautious about the luxurious goods.

Do you buy them to please yourself or to impress others? For most people, the pleasure you get from possessing a new luxurious good fades away within one week, but the pleasure may persist if other people pay attention to you because of this good.

However, there will be new design, new collections etc. (e.g. iPhone). People will soon switch their attention to whom own newer design and newer collection. If you want the attention back, you need to buy even newer design and collection.

Does it really make sense to look for attentions by entering this endless loop that will sucks your financials vastly? That is a trap that so many middle-class are stuck in, especially when the economies are good.

But luxurious good is not the only and not the most dangerous trap.

Are you the type of person enjoying a cup of latte every morning or ordering fancy lunch box offered by cafes close to your office? If so, you may have a huge leakage in your wealth. Again, there is nothing wrong to enjoy a good coffee or lunch occasionally, but spending on them every single day works against your financial goals.

David Bach’s famous <The Latte Factor> tells the exact story about how those tiny spending on daily basis eats your wealth away.

Because the economies slow down, installments become very prevalent. Previously, we pay installments to buy expensive technical products like laptops. But I am surprised to find that nowadays even an eye shadow allows installments.

Installment could be useful when you NEED to buy something that is on the pricy end while managing your cash flow. But installment also give you a delusion that your purchasing power is bigger than what you possess.

A very old study showed that seeing the logo of credit cards gave customers a sense that they owned more than their cash on hand, and therefore would tip more in a restaurant. Now you understand why the credit card logos always show up at the check-out and what they do to you.

Realizing those consumerism traps and taking preventive actions are one step closer towards your financial goals. For a very long period of time, myself was in such a convenient trap. But I am so glad that I eventually escape and am able to build a healthier spending habit.

4.2 Intentional spending

After fixing the leakage in your spending, we now deliberate how we will allocate the incomes. I call it intentional spending because we must be clear of the intention behind every single spending, including entertainment spending.

After learning from a bunch of resources including books, coaches, professors, and successful peers, I divide the spending into the following categories in the order of importance:

Life essentials
Funds
Debt repayments
Future Wealth
Learning
Entertainment

Life essentials are things we need to survive, like food. Of course, there could be different levels of spending on merely “essentials”. You will need some judgement here to determine which level that will balance your personal needs and to achieve your financial goals.

Funds specify the balances you need to reserve for emergency use. The reason to set aside the emergency fund is that you do not need to enter immediate but high-interest debt, like credit card debt, to tackle some urgent needs. When you set aside balance for funds, add it to the assets as well.

Debt repayments must be prioritized if the interest rates are higher than the average return of the capital market. For most people, I would recommend prioritizing debt repayments even if the interest rates are low, to avoid getting too comfortable in debt. A company can borrow loans as leverage, because it has limited liabilities. For individuals who have unlimited liabilities, taking too much risk may throw yourself deeper into the trap of debts.

Future Wealth is a category including your savings such as pensions or 401K in the US, and investments that will bring you the future wealth. Another type is the investments in mutual funds, stock markets, etc.. You spending on building or buying a company is also counted.

Learning, especially high-quality of learning, is a way to improve your capability of earning more efficiently and definitely worth spending. But in digital age, a lot of materials could be found without costs. Only those materials that summarizing expertise of 10,000 hours worth buying.

While I encourage saving more, it doesn’t mean that I appreciate a purely boring life. Therefore, we could budget for the entertainment category. This category contains everything like dining out, having vacations, paying for all kinds of fund subscriptions, and so on.

You can also set a vacation fund under entertainment if you want to spend a summer in a foreign country. Again, when you set aside balance for funds, add it to the assets as well.

The 6 categories cover most aspects of our lives. You can further customize according to your own needs. The principle is to align where you spend the money with your financial goals.

5. Personal budgeting

In the prior 2 sections, you set the critical foundation for a robust personal budgeting. The rest is very simple: entering your actual incomes and spending per category. The net balance of income minus spending to be added to your assets, whichever item depending on how you keep this net balance.

I personally prefer an excel spreadsheet or a Google Sheet rather than a fillable PDF that is prevalent on Etsy, because you can easily refer numbers cross spreadsheets and do calculations.

6. Reflection

Now you have your financial goals and your actual personal budgeting. Then you need to continuously reflect on your personal budgeting against the targets and revise if necessary.

For example, to reach your goals may require a more aggressive income or saving plan; alternatively, you may loose the timeline to achieve your goals considering that you have maximized your potentials but more time is needed to narrow the gap.

7. Inspirations

At last, I would like to share some inspirations with you and let’s achieve our goals together!

Stop waiting for permission
Don’t wish for it, work for it
The universe is on your side

Now you have learned how to set up a robust personal budgeting that supports you to achieve your financial goals and to increase your net wealth.