Budget bootcamp – are your finances inflation-ready?

With Consumer Prices Index inflation escalating to 9% in the 12 months to April 2022 and the prospect of hitting double digits by the end of the year, Alice Haine our Personal Finance Analyst explains why there’s no way to ignore the cost-of-living crisis anymore.

The financial squeeze is well and truly on and it’s here to stay for several months to come if not even longer. Absorbing the triple whammy of surging prices, higher taxation and rising interest rates is becoming trickier and trickier, with some households at the bottom end of the income scale left with little option but to raid their savings pot to meet everyday bills, or worse, run up debts they have little prospect of being able to repay. 

The harsh reality of rising inflation is that it eats into your purchasing power, meaning your take-home pay simply does not go as far as it did in the past. Something that might have been affordable even a year ago might now be out of reach as money gets swallowed up by everyday needs such as food and energy bills. 

But it’s not just low-income earners whose finances are hurting, middle-income earners (the median household disposable income in the UK hit £31,400 in the financial year ending 2021, according to the Office for National Statistics) and even some high-income earners are also struggling to make ends meet.

 

Inflation affects all to some degree and each person's exposure to rising prices will vary depending on their exposure to different costs. While the Institutional of Fiscal Studies estimate that the lowest earning 10% of the population may be enduring inflation as high as 10.9%, due to energy costs making up a bigger proportion of their household costs, affluent families living in rural locations with an oil-fired boiler and two vehicles will also be feeling the pinch too. 

With real wages on the decline, many are left with the uneasy feeling their take-home pay is only just covering their outgoings. As a result, taking control of spending is now imperative for everyone – particularly those who previously felt no need to track and plan their expenditure. To gain a firm grip on how your money is managed, the simplest solution is to create a budget. Here's one we prepared earlier...

Bestinvest's budget bootcamp

Our 11-step guide shows you how you can draw up an effective budget and take charge of your finances. This exercise not only highlights how much you have available to spend every month, ensuring you not only meet your financial obligations comfortably, but also what areas you are overspending on and how you can cut back.

Step 1: commit to the process 

If you are just doing this for you, then only consider your spending history and patterns. If you are compiling a budget for a household or family, then everyone needs to be on board with the process, so that you have a transparent picture of how the group’s collective finances need to be managed. 

Step 2: give your money a goal 

To create an effective budget, jot down what your short, medium and long-term goals are to fully understand how to make your money work harder for you. A short-term goal might be paying off your debt or going on holiday, while a medium-term goal could be saving for a wedding, buying a house or funding your child’s university education. Your long-term goal would be retirement and ensuring you have enough set aside to fund all your expenditure after you have stopped working. 

Step 3: the pre-budget fact check  

Rather than ‘guesstimating’ your income and expenditure – as people generally think they spend less than they do – gather your credit card and banking statements together along with any regular bills and tot up exactly where your money goes. An easy way to see all your regular payments is to check the direct debit and standing order lists on your bank account, while the rest of your statements will flag up other ad hoc spends on petrol, food and going out. 

You can either jot this down on a piece of paper, in a Word document on your computer or online document or spreadsheet. For a simpler solution, use a free, online budget planner or a budgeting app. These let you fill in all your expenses under different categories and then crunch the numbers on your behalf.  

Remember to include everything from your food shopping and regular bills, to mortgage or rent costs, savings and investments, including pension contributions, and debt repayments. And don’t forget to include one-off outlays whether it’s an annual car or house insurance payment, a holiday, a new piece of furniture for the house or Christmas presents. Take the total figure and divide it by 12 to get the monthly outlay. 

Top tip: don't calculate expenses twice. For example, paying for a hair appointment on a credit card which is paid off every month, comes under beauty expenses rather than credit card debt.

Step 4: follow the numbers from payslip to pension pot

Work out precisely what you earn by checking payslips to confirm the amount that hits your bank account after tax, national insurance and pension contributions have been taken out. If you have other sources of income, such as rental income from a buy-to-let property (minus all the monthly bills and expenses attached to that income), factor that into your budget too. 

Step 5: take stock and move on 

If you’ve been honest, then you will have a very clear picture of where your money is going – a picture you might not like very much if too many of your hard-earned pennies are being frittered away on wasteful expenditure. While the reality of your financial behaviour might make for difficult reading, it will also clarify why you might be spending more than you earn, or why you are only scraping by month to month and cannot save and invest. 

Step 6: streamline your spending 

Now that you understand where your money goes, you have the power to trim back spending on the things you don’t need and even those you do. If you are spending within your means, that’s great, but it is wise to eradicate any wasteful expenditure and help you hit your life goals faster through savings and investment top-ups. 

However, if you are spending more than you earn, then slash your expenditure now.  First, look at your like-to-have expenses and see which of those could go. Simple tweaks include taking a homemade lunch to the office rather than buying out, buying secondhand furniture and clothes over new and reducing visits to your favourite shops – whether online or on the high street. 

Just cutting out a £2.50 coffee on the way to work every morning could save you £550 a year, factoring in a month when you will be on holiday. Other cutbacks can come from removing monthly subscriptions to magazines, apps, TV streaming services, gyms and more. Scroll through your statements and highlight all the subscriptions in there – no matter how small – and then decide which ones can go. 

Step 7: go for gold – budget it all 

On the must-have list of expenses, there are numerous ways to trim essentials such as food. These include changing what you buy i.e. less meat and junk food and more fruits and vegetables, to cutting out the luxuries and deliberately choosing lower-cost versions of the same products such as supermarket own brands.  

Savings can also be made on financial products such as insurance – whether for life, critical illness, insurance, your car or the home – by shopping around for the best rates when any existing policies come up for renewal. 

Trimming your mortgage may be harder in this era of rising rates, but if you are on a variable rate, think about locking in a fixed-rate deal sooner rather than later to protect your outgoings from the raft of rate rises expected this year.   

For those in more severe financial straits, more dramatic cutbacks can be made through major lifestyle shifts, such as going from two cars to one, taking in a lodger to help pay the rent or even downsizing your home. 

Once you start the process of cutting outgoings, it can become addictive, particularly as the savings stack up and you have more money in your pocket at the end of the month – money that you can use to pay off lingering debts or save and invest to shore up your finances for the future. 

Step 8: one more budget? You can do it! 

If you are earning more than you are spending, or have managed to sufficiently trim your expenditure, you can now re-budget with your adjusted figures. This will evaluate what you have left over at the end of the month after all the bills and essential outgoings are covered. 

At this point, set fixed amounts to spend on certain categories, such as food, fuel, clothes, travel, Christmas, birthdays, etc. so that you know how much is available each month for a particular outgoing.

 

Step 9: money loves to work hard 

It's often a good idea to move any surplus funds into an easy-access emergency pot, such as a high-interest savings account. Many experts say it's good to have at least three to six months’ worth of expenses set aside for unexpected costs. You could then consider putting the rest of your surplus to work by potentially earning better returns than cash in investments. But remember that investing is higher risk than cash saving as the value of investments can fall as well as rise.

To maximise this, you could consider using tax-free options such as ISAs (Individual Savings Account) and SIPPs* (Self-invested Personal Pensions). You can save up to £20,000 a year into an ISA with no tax payable on your investments when you sell them or on any dividend income earned, while a SIPP lets your money grow free from income tax and capital gains tax with the Government topping up your contributions of £40,000 gross by 20%. Higher-rate taxpayers can claim another 20% through their tax returns and additional-rate taxpayers up to 25%. Prevailing tax rates and reliefs depend on your individual circumstances and are subject to change. 

Step 10: eyes on the prize  

With inflation eating into wages, it is imperative to stay the course as prices escalate higher. One trick is to have separate accounts for each spending category, such as a pot for holidays, a pot for unexpected bills or another one for Christmas, with a standing order from your main account to top up each pot. 

Top tip: automate all your bill payments through direct debits and standing orders at the start of the month, ensuring they are paid first. 

Going forward, when you come to make a purchase ask yourself: Do I really need it? If it’s a no, then strike it off your list. If the answer is a yes, then consider how you could make the same purchase more cheaply. Making this a habit will ensure you stick to your spending plan and in turn hit all your goals on time. 

Step 11: banish the blues – talk to an expert  

If you trim your expenses and still cannot afford your bills or find the whole process overwhelming, get help. Worrying about money can lead to feelings of anxiety, panic or shame and there is no point trying to shoulder the burden alone.   

 

Organisations such as Citizens Advice, the Debt Advice Foundation and StepChange Debt Charity can offer free, confidential support and advice tailored to your situation, such as getting out of debt as well as budgets and debt management plans. To manage stress more effectively, Mind and the Samaritans offer confidential telephone support lines to talk through problems.  

We can help you take on inflation

If you have surplus cash you're keen to invest we have oodles of free resources at Bestinvest – guides, jargon busters and digital tools – to help you take on inflation. Keen to talk to one of our friendly experts? Our knowledgeable teams can help you get your finances inflation-ready with a free coaching session. All our coaches are qualified financial planners who can help you set and track smashable financial goals. 

If you'd like to chat to us about where to begin our award-winning customer service team would love to help you. Give them a call on 020 7189 2400.

Important information

The value of an investment may go down as well as up, and you may get back less than you originally invested.

This article does not constitute personal advice. If you are in doubt as to the suitability of an investment please contact one of our advisers.

*SIPPs are not suitable for everyone. If you don't want to invest across different asset classes or don't think you will make use of the investment choices that SIPPs give you, then a SIPP might not be right for you. 

Prevailing tax rates and reliefs depend on your individual circumstances and are subject to change.