Now that you know how to budget your income as it comes in, it is important to start thinking about what the future holds financially. Being able to forecast future income and expenses is crucial to reducing financial stress. The great thing about this is that it really doesn’t require much additional work once you have a budget in place.
Many already forecast under the guise of budgeting. Recall that in FI 2: A Budgeting Framework I wrote:
Any budget that wants you to allocate money you have not earned yet is merely a forecasting tool. Forecasting future spend is important, but it’s more of a sidekick character; a “what-if” scenario. You are guessing what you’ll make, how you’ll spend it, and most likely not tracking it all efficiently.
It’s nice to think about and plan for but not the most effective way of doing this. When you budget with money you already have it’s far more impactful because any category you allocate to is funded right then and there. Budgeting should only be done with money you already have – not hope to have in the future. You can’t spend what you don’t have.
The difference between a budget and a forecast is that in the former, you can allocate real money already in hand whereas in the latter, it is merely a best guess. This is not to say that forecasting does not have its place. Companies have entire teams devoted to looking at future earnings, expenses, etc.
I personally think there is immense value in looking at our own financial future. After all, we generally know what our next paycheck will be (salaried employees more so than hourly or freelance workers but it can still be estimated). We know what our rent will be, the cost of our phone bill, the memberships we’ve subscribed to, etc. This is useful information because we can build a forecast that spans months out to use alongside financial goal setting (which will be discussed later).
We can use this forecast to run various scenarios. We can see how a paycheck or rent increase (or decrease) would affect our financial situation, whether we could afford to spend more in a certain category and what that might look like, etc. It helps us think about the future and help prepare us for what to do if a certain situation strikes. We can catch a potential issue (maybe something we should be saving for now) early to help prepare us.
With that said, the most important thing to remember is that none of this has actually happened yet. The very nature of the future means we don’t fully know what will happen. Be careful what actions you take based on what you forecast. Use it as a guide but your budget as a truth.
Hopefully now you understand how a forecast can help you look into the future. Join me next time as I discuss how to use budgeting and forecasting to set and work towards financial goals.
Continue to Part 5 – Goal Setting.