Manage your personal finances in Percentages

An office colleague of mine is a fresher, meaning that this is his first job. Naturally, he is quite enthusiastic and not jaded by preconceived ideas about work and processes. It is a pleasure talking with him and we often discuss about a lot of things, both professional and personal.


Sometime back, we got talking about managing personal finances. He shared the way he manages his salary. He said he sends Rs. 5000/- per month to his family, keeps Rs. 5000/- for his personal expenses, spends some amount on movies and hoteling and puts away the rest in savings.
(Please note that the amounts mentioned here are hypothetical).


I was curious to know how he arrived at these figures. He said he just put down these numbers based on his gut feelings.

"Well", I said, “There’s a better way to do this. Try managing your finances using percentages, rather than absolute numbers.”


What’s that, he asked. So I explained to him something that I realized only after a couple of years.


Using Percentages in place of absolute amounts
Consider that your monthly salary (or income) is Rs.100.
Now, note down all the expense heads that you regularly incur each month. This would include your rent, your monthly expenses on food, the electricity bill, water bill, mobile and internet bills, and so on.
Next, allocate a specific percentage of your salary (or income) to each of these heads.

For example, here's a suggested break-down:

• 25% of income to be sent to your family
• 25% for your monthly expenses, as discussed above
• 30% for savings and investments (tax savings, mutual funds, buying gold and so on)
• And, the rest 20% is towards a category which I call E-E-E (Tripple-E), which stands for Expense, Entertainment and Emergency.

Of course, the allocation mentioned here is just an example, and it will vary according to individual. Some may not need to send a regular amount to their family.

To summarize: Use percentages rather than actual amounts for each expense head.


What are the advantages?

This approach has a number of benefits.

• The most obvious benefit is that once you set up your allocation, it is flexible even when the salary changes. For example, suppose currently you earn Rs. 20k per month. Using the above allocation, it gives you Rs.5000/- for your monthly expenses. When your salary increases, all you need to recalculate the percentages. An Excel spreadsheet can do the job for you swiftly.
  
• Secondly, this approach brings out the relative importance of each expense head, thus (possibly) helping you make better finance decisions. For example, savings and investment are very important, so you need to allocate a bigger chunk of your income towards it, rather than, say, purchasing a funky new mobile when you already own a good one.
• The most important benefit of this approach is that it forces you to curb your unnecessary expenses. For example, if you have allotted 10% of your savings on entertainment; and if you earn Rs.20k per month, then the percentage-approach restricts you from spending any more than 2000/- on entertainment.

Of course, this is assuming that you take your plan seriously and are honest with yourself. If this is not the case, then there is not much in the world that can really help you!

My colleague has been trying this method for a while now, and says it has made his money matters significantly better. Hope it works for you too!