To begin with, let me ask a simple question, what we do with our income? No matter who we are, salaried or self-employed, categorizing income will benefit everybody.
Generally people earn income in the form of salary, sales, investment returns etc. For effective money management, it is essential to create a break-down of ones income.
How such a break-down will help in effective money management? We will not answer this question right here. Lets proceed with the identification of categories first. Effective money management will be discussed simultaneously.
Different people use their incomes in a different ways. But all in all, we can categorize the use of incomes in the following ways:
- To manage day-to-day spending needs
- To manage short term goals
- To manage long term goals
- Tax saving investment
How Categorizing Income Is Effective?
As a rule of thumb, money allocated between ‘Expenses’ and ‘Investments’ should be 50-50.
But from my personal experience, such a distribution is not easy. Even today (I consider myself low in debt), my expense vs investment proportion is 52-48.
Majority people has the proportion between expense and investments completely skewed. It is not uncommon to find a proportion like 80-20 in favour of expense.
This is where categorizing incomes will come into help. Categorizing will help one become aware of the income utilization.
If more than 50% is going in expenses, it means you are over spending. The ‘degree’ of over or under-utilization of expenses is also evident when categorizing of income is done in a proper way.
When I first used the concept of categorizing income for myself, the allocation between expense and investment was as high as 81-19. This is where I first became aware that how much extra expenses I have exposed myself to.
But over a period of time the proportion between expense and investment has come down to 52-48 levels.
If I can do it, anyone can. I am one of those impulsive spenders who does nothing for extended period of times, but suddenly indulges into big purchases. I have still not changed this habit, but for sure the spikes have been toned down.
How I achieved this? Two things that contributed most in my balancing act was:
- Creation of categories and sub categories of my income. I allocated every penny I was earning to expenses and investments.
- Reducing my debt load by nearly 75%
Here are Some Best Money Management Tips by Categorizing your Income
1. Make an Income Breakdown
The first step is to do a total of all expense and investments. Check if this total value is equal to the total income or not.
If the total of expense + investment line items is more than your income, this situation is not manageable. It is better to have a re-look into the quantification of expense + investments line items.
Total Income must be equal to Expense + Investment.
Today, any money that flows out (expense or investment) of my bank account (accumulated income) has a clear tag attached to it.
The money that flows out is either tagged as expense or investment.
The idea of such tagging was that, I should remain constantly aware of my Expense-Investment proportion.
Target is to keep the proportion within 50-50 range at least.
2. Create An Expense Line
Preparation of expense line items is simple?
At the outset, this sound rather a simple exercise. But actually its not so simple task.
The target is to list down all cash flows (expense, savings & investments) which consumes our income.
Suppose My income is ₹1,200,000 each year (₹100,000 per month). When I started listing and quantifying my expenses, to my complete surprise, I could account for only ₹60,000 each month. Where the balance money was going?
When I could identify only ₹60,000, I became confused and anxious. I wondered, where my money was going all these days? I was not able to even remember where I was spending them.
This is what is called as impulsive spending. When people spend money without budgeting & tracking, they end up being an impulsive spender. This is an undesirable state of mind.
I seek help from my family. After deliberation with family, the ₹60,000 figure went up to ₹70,000. But still there was a big gap.
It took me nearly a whole week to figure out where my money was going.
While I was doing this exercise I made a pledge to myself that, henceforth I will start recording all my expenses.
Money Management: Conclusion
In normal terms we call this categorizing income as preparing a budget and cash flow.
What we have done here is exactly the same. But I feel that, viewing budgeting and cash flow preparation from this angle helps to unearth the real meaning of the same.
The bigger purpose of preparing a budget and cash flow is that, it should help in more effective money management.
Categorizing Income the way it is explained here also allows Effective Money Management.
In fact for me, it worked very well because I have combined budgeting with cash flow preparation (income vs expense balancing as explained in step #2).
This is also true that only categorizing income is not sufficient. In parallel to this, one must also use tools for expense recording and tracking. Once done like this, effective money management will become a reality.
Always try to keep expenses percentage low and savings+investment percentage high. This will make you good fortune over the period of time. Just a simple advice, rest it’s your money spend them the way you like.