Tips from Pravin

THE humble budget remains the cornerstone of long-term financial wellbeing for individuals, companies and countries.

While successful companies and most countries throw expensive resources at ensuring that they run solid budgets, individuals largely ignore the importance of budgeting in managing their personal financial affairs.

Favourable economic conditions between 2004 to 2008, coupled with rapidly rising incomes, saw many throw their monthly budgets out of the window as cash became more readily available. As a professional assisting people with managing their personal finances and growing their wealth, I am often amazed at how few of them actually have a monthly budget - and stick to it.

Consumers are currently facing significant demands on their income. High fuel prices, increasing electricity costs, potentially higher interest rates and ever-increasing food prices have all contributed to a much higher cost of living than inflation statistics suggest.

All this adds to the need for people to give more attention to their budgeting habits.

The question is - what does one think about when drafting a monthly budget? Is a budget simply a record of cash flows? Can it be used more strategically when it comes to personal financial management?

I was particularly interested in a section of Minister of Finance Pravin Gordhan's 2011 budget speech, where he spoke about the principles that are applied when putting the national budget together. I quote:

• A counter-cyclical fiscal stance, to counteract variations over the business cycle;

• Long-term debt sustainability, to ensure that financing costs do not crowd out expenditure on public services, and

• Inter-generational equity, so that our children's wellbeing is not compromised by short-term interests.
  

It got me thinking about my own budgeting habits for the first time in ages. I've managed my financial affairs according to a monthly budget since my first job at varsity in 1992. Over the years the numbers involved have become bigger and the budget slightly more sophisticated, but for the first time I've stopped to think a bit more strategically about my budgeting habits.

Can I, or any individual for that matter, ride on the coat tails of the brains trust that manages the country's budget, and apply these principles when doing my own budget? If yes, how?

The short answer is: yes, I can - yes we can (my Obama moment right there). The challenge then is how?

Principle 1: A counter-cyclical fiscal stance

This essentially means saving in the good times and investing/spending in the bad times.

This principle makes a lot of sense, especially if you think about the past six years in the SA economy. We witnessed one of the strongest periods of economic growth characterised by high consumer spending - followed by the worst economic conditions in 30 years.

During the good times, we saw the property market shoot up to levels where properties became ridiculously over-priced and unaffordable. People who bought property during this time are struggling to maintain their monthly payments, and many have sold out at a loss.

In many cases, one can now pick up similar properties for as much as 20% to 30% lower. If you had applied this principle over the past six years, you would have been saving during this time (and achieved very strong returns in most cases) - and would have had money available right now to buy assets for much cheaper than they were a few years back.

Principle 2: Long-term debt sustainability

This principle essentially means that one's budget should have capacity to withstand a sharp increase in interest rates.

It also means that the amount you spend on maintaining debt obligations does not constitute a significant portion of your budget. Again, we can look to the recent economic cycle to see this in action.

In 2009 the big four banks experienced a massive increase in the level of bad debts as a result of borrowers reneging on their debt repayments as interest rates rose sharply, making previously affordable properties and vehicles unaffordable. Interest rates went up by more than 5% in a very short space of time.

Consider an individual with a R1m home loan and a R250 000 vehicle loan: a 5% increase in interest rates would have bumped up monthly repayments on his car and house by R4 000 per month. If debt servicing made up a large portion of his budget, chances are that he would have been among the sad statistics of 2009/2010.

Financial experts recommend that you allocate 30% to 40% to debt repayments, so someone earning R20 000 a month should not be spending more than R8 000 a month servicing debt. Statistics released by the National Credit Regulator suggest that the average R20 000 earner in SA is paying R15 000 a month servicing debt.

Principle 3: Inter-generational equity

This principle is essentially about ensuring that we have one eye on the future when allocating money on a monthly basis.

Our current spending habits should not prejudice our children. There is absolutely no reason why the next generation should not be better off than the current one, and it should not cost the earth to make that a reality.

The main factor in favour of providing for the next generation is time; a newborn will only really need some kind of capital injection in 18 years, upon leaving school. An investment of R500 a month for 18 years at an average return of 14% per annum should grow to around R940k. It will cost R108 000 in contributions, if they grow by 10% over the period.

Another example of prejudicing the next generation is insufficient life cover to provide for children's ongoing needs - education, clothing, shelter, etc - on the death of a parent.

In conclusion, the principles governing the national budget appear to be easily applicable to our own budgets. If applied correctly, this can have a meaningful  impact on the effectiveness of your budget in your own personal financial management.

Recent economic experience suggests that if applied over time, these principles can contribute significantly to your own quality of life as well as that of the next generation. This should go some way to restoring the humble budget to its rightful place as the foundation of effective money management.

After all - money remains a wonderful servant, and a terrible master.

* Craig Gradidge is a certified financial planner and a co-founder of Gradidge-Mahura Investments.