Stress Test your Budget
Once you have built a budget, you may think the hard part is over with and it’s smooth sailing from here on. If this is your thinking then you are in for a tough lesson. So let’s ask a basic question: how did you build your budget?
Mostly we list our income and expenses, hoping to balance the budget or ideally saving something every month. While there is nothing wrong with this process, there is a critical exercise missing from this process. We build our budget naively thinking that nothing will go wrong and hopefully follow through with the plan we have set.
If you are building a budget then you most likely understand the power of budgeting and are ready to put it into practice. But we have to use our budgets to their full potential.
In our rush to build a budget, we forget to stress test it. The idea is to understand, well, if things go wrong, if I can’t stick to my budget, what’s the negative impact on my finances. Or thinking positively, what is the positive impact if all my plans fall into place.
When studying economics, we were always told to assume ‘all other things be equal’ when looking at possible outcomes to a scenario. Stress testing your budget is the same principle. Assume everything stays the same but change one expense or income category, now how is that going to impact you financially. Keeping changing different parts of your budget to look at the outcomes.
I am not talking about a planning for the job loss scenario. For that scenario, you need a more robust plan. This is merely looking at your budget one month at a time, it is more of tinkering with your budget to see what happens.
Possible Budget Outcomes
This process will give a range of different possible outcomes. Armed with this knowledge you can now prepare for the worst possible outcome if you are under financial strain and build a budget that protects you from that outcome. This process can help you plan for the end of the month where you know you may end up in the worst case scenario, perhaps you may need to dip into savings to meet your financial needs.
The lesson is to adjust our budget to weather the negative scenarios. It may seem like a pessimistic view of our lives but budgeting is about discovering and facing hard decisions. It helps to prepare for the worst while working diligently to ensure it does not happen.