How to budget if you’re living pay cheque to pay cheque

Published on 16th April, 2021 at 04:25 pm

We asked financial experts about the key to getting this right and growing closer to financial freedom.

One budget doesn’t fit all

In her book All Your Worth: The Ultimate Lifetime Money Plan, author and US senator Elizabeth Warren popularised the 50/30/20 rule for budgeting. Used as a guide for dividing up your income, it suggests 50% of your taxed income is spent on needs, 30% on wants (discretionary spending) and putting the remaining 20% away towards financial goals. In theory, the rule portions out your income to ensure your needs, wants and savings goals are met, regardless of your income bracket. But does this work in practice?

According to Jyoti Gopee, a financial planner at Pinnacle BlueStar, it’s not as simple in the South African context. “I think the split should be amended for present times: 50% for needs; 30% for financial goals (taking into account that financial goals include debt repayment) and 20% for ‘wants’.” A mere 20% towards wants sounds like a big sacrifice, but bumping your financial goals up to 30% means you would be in a better position to financially free yourself in the long term. And we need it, considering how 70% of South Africans’ household income currently goes towards servicing debt. To add, Statistics South Africa reported in the second quarter of 2020 that we were only putting away 1 cent for every rand we earned. “It doesn’t make sense to spend 30% of our income on ‘wants’, as we have found that many clients do not have an emergency fund established, or their provisions for a retirement annuity (RA) are far too little to provide for their actual income and retirement capital needs, or savings accumulated for their children’s educational needs are simply not enough,” notes Gopee.

Here are some money habits you can set to help you on your way to financial freedom.

Pay cheque-to-pay cheque budgeting tip #1: Focus on debt

When you save, you’re giving yourself financial freedom. When you take out credit, you’re borrowing from your future self – and potentially delaying that financial freedom in the process. “Ideally 30% of income should be spent on financial goals, inclusive of servicing existing debt,” suggests Gopee.

Pay more than the minimum
As tempting as it may be, avoid paying the bare minimum instalments to eliminate debt.

Avoid debt re-advancement – if you can
“Often, clients access the cash they’ve already paid towards their loan via a re-advance facility, which most credit providers offer,” says Gopee. “This means the debt just gets further extended.” That said, it could make sense to make a re-advancement on a home loan, an example of responsible credit, if it can help you eliminate something like a store card or personal loan. Discuss your options with a financial planner, who will be able to assist in making the decision best suited to your financial situation.

Understand your agreements
Common among motor vehicle finance options, a balloon payment is a lump sum you need to pay at the end of the finance term, and is much larger than all the payments you would’ve made before it. Often car owners aren’t prepared for this payment. “When the balloon becomes payable, clients refinance the balloon, thereby extending the credit term. Alternatively, clients opt to purchase a new vehicle via finance and include the previous balloon payment into the new credit agreement (i.e. increasing the capital debt),” shares Gopee. This continues the debt cycle and delays your financial freedom for another finance term. To avoid this, make sure you understand the terms of any finance agreement you enter into, and budget to save towards a lump sum to avoid any nasty surprises. Read this guide to help manage your debt better.

Target high-interest debt first
If you have multiple debts, there is a smart way to eliminate them and transform your budget into one that helps grow your wealth. Gopee has some tips: “When paying debt, create a list of all the institutions to which you owe money, and alongside it, the capital balance owing and the rate of interest that is charged on the debt. Then look to increase contributions towards the institution that is charging the highest interest rate – thereby reducing the capital debt and loan term sooner than the initial contract.”

Pay cheque-to-pay cheque budgeting tip #2: Prioritise saving

A strict approach to how you split your income between financial goals and short-term discretionary expenses is key to prioritising saving when you are living pay cheque to pay cheque. The initial discomfort of putting more money towards financial freedom will be balanced out when debt is no longer a line item in your budget. Plus, once you’ve eliminated debt, the fraction of your income that would’ve gone towards repayments can now start growing into a sizeable amount of savings so you can realise your financial goals.

Use this savings tool to help grow your wealth.

Pay cheque-to-pay cheque budgeting tip #3: Cover non-discretionary expenses first

Your non-discretionary expenses, or needs, should be factored in before you start looking at discretionary expenses, or ‘wants’. “To try curb discretionary spending, it will be easier to list those expenses from most important to least important,” says Gopee. “You can then remove or further reduce the expenses that appear last on the list.”

Pay cheque-to-pay cheque budgeting tip #4: Get negotiating

Negotiation can be powerful when trying to reduce set overhead costs such as insurance, rent etc. But before you call your broker, meet with a qualified financial planner so you have an expert on your side who can help you draw up a budget. “Share at least three months’ bank statements at the same meeting with your financial planner to make sure that all expenses were captured and for them to understand your spending habits,” says Gopee.

Looking at your budget, scan for ‘small’ expenses like certain risk premiums. These aren’t so small when tallied up over 12 months. “A few changes to these smaller expenses will make a fair improvement to your monthly expenses,” says Gopee.

She shares an example:
“I often find that clients maintain their building insurance for their primary residence with the financial institution who assisted with their initial bond for the same property. The client will have a second short-term policy with another insurer to cover their motor vehicle/s and house contents. If you combine all your short-term insurance (building, house contents, motor vehicle/s) on one policy, you have leverage to negotiate a better discount with your insurer and you will pay a policy fee to only one insurer, instead of two policy fees.”

Use these tips to negotiate better and get what you want.

Use the Wealth Sense calculators to help you work out how much you need to save each month to create a budget that helps you reach your financial goals.