This new budget leaves a monthly surplus of £464. John plans to reduce his outgoings by:
Getting a cheaper TV package.
Getting a cheaper sim-only mobile contract.
Paying off debts.
Stopping using his overdraft.
Reducing day-to-day spending.
Getting there won’t be easy for John, as part of the plan involves paying down his debt in order to free up a surplus every month. So, he takes it step by step. Cancelling the TV package and reducing day-to-day spending frees up £299, and he uses this to pay off debts quite quickly. He also decides to temporarily cancel his Netflix and gym subscriptions to speed up the debt repayment. This method is called ‘snowballing’. Within 5 months, John has paid off his debt and also generated a surplus amount of income every month.
Step 5. Save surplus income every month to create an emergency fund
Let’s assume you have also reduced your monthly fixed outgoings as much as possible, and got a handle on your day-to-day spending. Each month you receive a salary after tax. You transfer £450 per month to the app-based account, for your day-to-day spending. You leave £1100 in the current account for your fixed monthly outgoings. You should then transfer the £450 that is left over to an easy-access savings account.
You should ideally save in this way until you reach a point where you have 3 months’ worth of outgoings, both fixed outgoings and day-to-day expenditure. So that would be (£1100 + £450) x 3 months = £4650. This money can then be used as an emergency, for when you experience large unexpected costs. This will stop you accruing unexpected debt in the future.
Hey presto! Just like a well-run business, you now have a healthy monthly budget and a good reserve.
Some personal finance experts suggest you save up for this emergency before you start paying off debts. All of this depends on how much free cash you can generate in your initial budget session.
Step 6. Start investing
Now you have an emergency fund saved, and are living within your means, you are now in a much better position to start looking at other savings options, for example, ISA allowances, saving for a buy to let, etc.
One thing that also needs to be considered in your household budget is managing your risk of being unable to work through accident or sickness. As without a protected monthly income, this entire process does not work. So, in the next article we will look at that.
Next article – How to prepare for a mortgage: 2. managing future financial risks (LINK)