Before you can do anything in life, you have to understand and accept where you currently are and ideally where you came from. This is a general rule of thumb, no matter what you are trying to achieve.
Let’s use employment as an example, if you are applying for a job at a company, the employer really has to judge you based on your past successes and failures. They have to analyze your previous history of work, education, extra curricular activities, volunteering etc. and determine whether or not you are a match for the role and the company. The first thing an employer will do when reviewing a potential candidate is look at their past, before determining whether or not they will be a success going forward. They will then invite the candidate to interview and ask them a series of questions regarding their history in employment and education and perhaps regarding their present skill set that will be beneficial to the company, before finally contacting their references to confirm that the past they portrayed is indeed an accurate one. If they are lucky, their past and present self will have been determined to be a good fit going forward, and they will land the job.
The moral of the story is you really have to understand not only your present self, but also your past, before you can really succeed at anything going forward. That includes all the positives, such as your successful stint at Chuck E. Cheese, and the negatives, such as your subsequent firing from Chuck E. Cheese. It’s only when you fully understand your past and present self that you will be able to move forward without going around in circles.
Past Behaviour is the Best Predictor of Future Behaviour
In terms of creating your own financial path, the same can be said. Your most reliable predictor for how much money you will earn in the future, as well as how much you will spend, is your past. If you have no idea how much you spent on groceries last year, how on earth will you know how much you are likely to spend next year, or even next month? This information is the most powerful tool you can have when it comes to budgeting your finances, and too many people go through life without fully grasping this fact.
Knowledge is power, the whole world runs on it. Just look at Facebook and Google, what makes them two of the most powerful companies on the planet? Correct, data. The more data you have, about anything, the more likely it is you will be able to make an informed decision going forward. Facebook and Google make most of their money from advertising, because they know basically everything about you and sell this data to other companies who want to target their products towards you. Therefore, by amassing vast amounts of data, Facebook and Google can actually predict your future spending and sell this information to other companies. You need to become more like Google! Think about it, if you have absolutely no data whatsoever, you’re completely blind. You don’t know where your money is coming from and where it is going. You have no idea where to even to begin with a budget, but begin you must!
I have numerous friends who have no idea how much they spend on, well, anything. Some of them make significantly more than average wage, yet have no knowledge of where that money is going and no savings to their name as a result. It blows my mind how little care people take in their own financial situation, yet when Pokemon Go releases an update, nothing else in the world matters.
When I sit down with our executive team at the end of the year to determine our corporate budget for the next fiscal year, the first thing that gets looked at is last year’s budget, actual results and variances, before considering any changes that might happen in the next year. In very simple terms if there are no changes expected, the budget remains the same as last year. Generally, past performance is the best starting point for future expectations.
Okay, okay we get it. Stop flogging a dead horse. What’s next?
Okay, so, before you can effectively budget your money, you need to develop an understanding of where your money is going. In a world of online banking, credit cards and instant access to your accounts, it is pretty likely you have this information at your fingertips, waiting to be analyzed. If you do not have this information easily available (do you live in the 90’s?), I suggest before you move onto budgeting you develop an understanding of where your money is being spent currently. Over a period of months (I’d say at least 2-3 to get a reasonably accurate average), keep track of your spending however best you see fit. I like to use online tools like YNAB or Mint as these are both convenient for not only seeing where your money is being spent, but also for budgeting where you think your money will be going in the future. I’ll write a more detailed article on these later. If you prefer to take a more manual approach, you can simply keep a record of your expenses in excel or even on paper if you’ve been living in a cave for the past two decades.
Make sure you categorize expenses in a way you understand them. These can be as specific or vague as you like (more specific the better to gain a thorough understanding). Some obvious ones are Rent, Groceries, Restaurants etc. but we even keep very specific ones like Pet Food, Coffee Shops, Navel Fluff Collecting and Extreme Ironing Meetup Expenses.
Once you have developed an understanding of where your money is being spent, it’s time to move onto budgeting your future income against spending.