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Balancing your budget, emergency funds and other reserves

A budget that is balanced is one where there is enough income coming in to pay for all of the expenses. Ideally, you want to have a budget surplus, where you have more money coming in, unless building your savings is already an item in your budget. This is because unexpected expenses can crop up from time to time – emergencies and other surprises. Building an emergency fund or buffer can help your multi-year budget deal with the year-to-year differences that will appear. The reserve fund adds a greater margin of error in balancing your budget. Some expenses will also only appear in certain periods. Taxes, for example, may only be due once a year (every three months for some), so you may need to plan ahead and save for them each month. Major home repairs can be even less frequent, requiring that homeowners plan to save over multiple years for some expenses.

A budget shortfall, where expenses are greater than income, can lead to drawing down your savings, or going into debt. Achieving a balanced budget can relieve a lot of stress in a person’s life, even if it means sacrificing some discretionary spending. This psychological trick has been known for centuries, as Charles Dickens put it:

“Annual income twenty pounds, annual expenditure nineteen pounds, nineteen shillings and six pence, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery”

Framing budget decisions in different ways can also help make the decisions easier to make. For example, increasing your budget surplus (your savings rate) from 5% to 10% may sound daunting – a doubling of your savings rate! However, it only requires that you cut your spending from 95% to 90% of your disposable income, a much more achievable-sounding reduction in your spending.

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