3.2 Setting a budget – things you need to think about
You’ve seen that to determine a budget, both income and expenditure need to be considered. Once these have been established there are two other things that should be reviewed.
First, what does the total amount of spending need to be in relation to your income each month, now and in the future, to enable your financial objectives to be achieved – for instance, paying off your mortgage or paying for your holidays?
Second, should the pattern of expenditure be changed?
Of course, it’s possible to be happy with the total amount of expenditure in relation to income but nevertheless to want to alter how that money is being spent. In other words, you might want to change the pattern of your spending. To illustrate, if someone wants both to do more for charity and to lead a healthier lifestyle, they may decide to give money to their favourite charity while buying fewer music downloads, and to join a gym instead of spending evenings in the pub. These don’t require a change in the total amount of expenditure, just a change in the pattern.
Decisions on changing the pattern of expenditure involve trade-offs: giving more to charity means a trade-off in terms of buying fewer music downloads. Another way to put this is in terms of opportunity costs: the opportunity cost of giving that money to charity is the music downloads that could have been bought. Put like that, it doesn’t sound much of a contest, but trade-offs also apply to more hedonistic options such as going out clubbing versus paying to see your favourite football team. Remember that opportunity costs work both ways: the opportunity cost of drinking in the pub is not being able to join the gym (as well as the direct health risks), and the opportunity cost of buying the music downloads is not being able to give that money to charity.
In Jenny’s case, she’s set herself the goal of reducing, or eventually eliminating, the gap between her income and her expenditure, and the goals of building up an emergency saving fund and paying off her personal loan – all at the same time. There are different approaches she might take to achieve all of this, as you see next.