Budgeting

Episode #1 Budgeting, your key towards financial independence

By François P. & Vincent M. 09 January 2022
Episode #1 Budgeting, your key towards financial independence

Episode #1 - Personal Finance 101

Investing can sound like a daunting task, requiring millions in the bank account and an expert knowledge about the stocks market. In the Jeune-Investisseur series, we think different. We believe it’s possible to start small and achieve your financial goals in the long term. This blog is a summary of our discussion on the Jeune Investisseur Podcast. In this first episode, we introduce the topic of personal finance and the key elements to consider before investing.

What we talk about in the Jeune Investisseur series

  1. Everything personal finance ~ budgeting and interest rates (you are here!)
  2. Inflation and what it means for your investments
  3. Finding an investments strategy which matches your goals
  4. Getting real - tools & methods for investing

In this first episode, we go over the primary concepts you should think about when starting your investing journey.

⚠️ The content of our podcast and production is Not Financial Advice. Do your own research or contact your financial advisor before making a serious financial decision.

Personal finance - What does that mean, anyway?

Personal finance can be seen as how you handle your hard-earned money. Simply put, think of it as what happens between your incomes (salary, dividends) and your spendings (mortgage, loans, groceries and other daily expenses).

Managing your finances is ensuring that, every month, your total income covers your total expenses. Incomes - Expenses > 0. Two main reasons are:

  1. Avoid defaulting on certain payments, e.g. mortgage or student loans (this could decrease your credit score, thus making it harder and more expensive to secure a loan)
  2. Save a minimum amount every month - which you can then use however you desire: investments, holidays, outings etc.

In a nutshell, managing your personal finances is about striking a balance between maximizing inputs and minimizing outputs, making it possible to grow your capital. To get started, a simple tool like a budget will take you far in owning your financial independence.

Making a budget and sticking to it

Here’s a little secret to making your budget effective and actually sticking to it:

  1. Review it regularly (e.g. every week works well for us),
  2. Do it manually - and by that, we mean manually typing in each of your spendings.

Reviewing your budget regularly will help put your spendings in perspective with your monthly goal and adjust accordingly. Additionally, reviewing your budget regularly (e.g. weekly) means you’ll have fewer spendings to triage, so the task may take as little as 10 mins to complete - rather than if you were to review your expenses from the last 3 months, which could be daunting.

Manually entering each of your spendings will give you a sense of where your money is going.

For instance, if you type “takeout” 5 times and realize it is a considerable chunk of your food budget, you’re more likely to adjust your eating habits and find incentives in cooking at home.

No need to use a budget app chock-full of features - Actually, the simpler, the better. Keep It Stupid Simple as we say in engineering. Your favorite spreadsheet editor, a few columns, and you’re good to go! You can download the budget template we personally use here.

Many apps propose to handle budgeting for you today, either integrated into your bank app (e.g. Revolut and N26) or with an account aggregator (like Bankin'). However, after trying each of those options, we circled back to the spreadsheet for budgeting. Two reasons:

  1. Nothing will give you a reality check more than manually inputting each of your spendings. Doing so helps realize which spendings you’re not comfortable with. A budgeting app would list and triage your spendings automatically, meaning there’s less incentive to ask yourself whether this particular expense matches your financial goals or not.
  2. Also, budgeting is not a one-time exercise - rather it should be something you continue practicing as your life changes. What would happen if the budgeting app you’d been using goes out of business and with it your budgeting history? Keeping your budget history is important, as it helps compare your monthly expenses of today against the ones of a few years ago. Such a long-term comparison can help you spot the effects of lifestyle creep - when you consider as necessity something you used to consider as luxury when you had a lower income.

Budgeting is your first exercise before thinking about investing. Simply put, investing requires money, and a budget will help you set aside some €$£ each month.

Before going bananas on the stock market, let’s ask ourselves 2 questions:

  • Do we have any debt? If so, let’s think about interest rates.
  • Do we have a personal emergency fund? If not, let’s set up one.

The impact of debt

Debt - in the form of student loans, a mortgage, a vehicle loan or credit card debt - isn’t intrinsically good or bad. It may help you achieve an objective when you didn’t have the necessary funds for it initially. See it as a leverage.

However, in most cases, debt is tied to interest rates. It’s important to take a couple of minutes to understand how they (generally) work and what are their impacts.

Understanding interest rates

We’re somewhat ashamed to admit it, but even though we both have MScs, we understood how interest rates work only a few months ago, when François went through the process of getting a mortgage.

In most cases - e.g. when applied to credit card debt, student loans or a mortgage - an interest rate will be expressed as a % - like 1.5%. It is however simply not just a % of the principal (the amount borrowed) - because it compounds over time, in one way or another.

Here are a couple of explainers for certain types of interests:

It’s easier to understand with an example:

This artificial example is only to illustrate how interests can compound over time. Always ask your lender which interest rate you’d get and how it’d be applied.

Let’s say we take a loan of 15 000€ over 1 year with an interest rate of 3%.

At the end of the year, we pay back the capital: 15 000€ as well as 3% of 15 000 = 450€ of interest. Simple.

Year Capital Reimbursed Interest paid Total paid this year
1 15 000 € 450 € 15 450 €
  • Total interest paid over the 1-year loan: 450 €

Now, let’s say I take a loan for the same 15 000€ with the same interest rate of 3% but over 3 years. We pay interests on the remaining capital to reimburse every year.

Year Capital Reimbursed Interest paid Total paid this year
1 5 000 € 450 € (3% x 15 000) 5 450 €
2 5 000 € 300 € (3% x 10 000) 5 300 €
3 5 000 € 300 € (3% x 5 000) 5 150 €
  • Total interest paid over the 3 years loan : 450€ (year 1) + 300€ (year 2) + 150€ (year 3) = 900€
    That’s twice the cost of the 1-year loan!

As mentioned above, we’re certainly not suggesting that loans are evil and should be avoided as much as possible. There’s a reason mortgages and student loans exist: it’s hard to come up with the upfront capital these endeavors typically require.

However:

  • Keep in mind this trade-off between the duration of your loan and the total interest cost to find the best balance for you.
  • Be like the Lannisters and pay your monthly payments on time. Not doing so could negatively impact your credit score (i.e. your ability to borrow money). Coming back to our budget, be sure you list these monthly payments first and will have enough to cover them.

That’s close to everything we wanted to cover for this first episode. One last thing to consider before starting your investing journey:

Securing your personal emergency fund

Rainy days are to be expected as life happens. A sudden reduction in your monthly income, a severe injury or an unexpected broken appliance can limit your ability to provide for yourself and your family. In these moments, it is important to have easily accessible funds to quickly react to these unforeseen difficulties.

Having the cash equivalent of ~3 months of expenses (adjust according to your own situation and risk tolerance) readily available (e.g. on a checking or savings account) will help you if such times arise, limiting the risk to compromise your long-term investments & financial goals. Easily accessible cash (i.e. with no fees) will ensure you don’t need to sell your investment on short-term notice, putting yourself at the market’s mercy.

Wrap up ~ Key action items

The key elements around personal finance can be summarized in 3 points:

  • Make a budget, as simple you can, and stick to it. It will give you a sense of how much you can put aside every month for investing, your emergency fund, or simply enjoying life.
  • When contracting a loan, understand that interests usually compound over time. Make sure you understand how much capital vs interests you’ll pay off every month.
  • In times of emergency, cash is king. If your boiler exploded, you wouldn’t want to sell your $AMZN shares to buy a new one. Ensure you have an emergency fund ready to cover ~3 months of expenses for life’s little surprises.

Following up on the theme of interest and rates, we’ll cover inflation in episode 2 and how it impacts your finance. Listen here!

Subscribe to our podcast to stay informed of investment and personal finance protips. Subscribe here

Bibliography

Here’s a list of the resources that inspired us in making this episode.

Header image by Diane Helentjaris on Unsplash