Why You Need A Budget

The article below was published in Canadian Money Saver magazine in September 2009.

In my last article, I talked to you about why it’s important to start thinking about money and the future at a young age – the earlier you start, the better off you’ll be.  This month, I want to talk to you about budgeting.

About two years ago a friend of mine finished school in the US and decided to come back to Canada.  He wasn’t sure how long he was going to stay in Canada as he was thinking about moving to another country.  Because of this uncertainty, he didn’t know what kind of budget he needed to set, or what type of financial goals he needed to create, so he tried to save as much money as possible.  However, he did realize that he would probably stay put for at least a year and wanted to get a car to make his life easier.  When it comes to cars, there are a lot of options, but he decided to lease a new car for a three year term thinking it would be easy to get out of if he wanted to leave the country – he was willing to pay a premium to have flexibility.  The car’s monthly lease payment was $400.

Two years later, my friend realized that he was going to stay in Canada for the foreseeable future, but quickly figured out that the car he had originally leased didn’t make sense to keep – the lease payments were so high that he wasn’t able to save enough money each month to put into his savings and the buyback of the car at the end of the lease was too high – he decided he wanted to downsize to a used car with a monthly cost of about $150, saving him $250 each month, or $3,000 each year.  My friend is in the process of getting out of his lease so he can get a cheaper car, but he’s spent $9,600 for the luxury of uncertainty – basically because he was not sure what he wanted to do, he decided to lease a new car and paid a premium to do so.

Now the question is not what can he do, he has that figured out, the question is what could he have done differently two years ago?  First, let’s assume that buying a new car was out of the question (because of how fast new cars lose their value, you really have to own a car for at least six years to make it worthwhile), and it probably doesn’t make sense to lease a used car – typically this costs almost the same as leasing a new car.  So the options are to either lease a new car or buy a used car.  If he had bought a used car, he could have found one that he would have been happy with for between $10,000 and $15,000, and assuming he was able to negotiate financing, he could have monthly payments of $150.  The table below quickly summarizes the options.

	Lease a New car	Buy a used car
Monthly Cost	$400	$150
Accumulated Cost (Two Years)	$9,600	$3,600

As a worst case scenario, if he bought a used car for $15,000 and sold it two years later for a 50% discount (which is a huge discount), his total outlay would be $7,500; in all likelyhood, after two years of use, he could probably sell his car for between a 30 to 40% discount.  At the end of the day, a used car would come out to at least $2,100 less than leasing a car.  Unfortunately for my friend, he never evaluated his options; he just decided that leasing a car was the best option.  If he had worked out the numbers, he would have quickly seen the better route for him (keep in mind, his primary goal was to save as much money as possible) was to buy a used car.  Instead, he’s paid $9,600 to lease a car, will probably have to pay a small fee (between $500 to $3,000) to get out of his lease, and at the end of the day, will have to pay another $15,000 for the car he is going to get.

Now I’m not trying to scare you off leasing a car, a lot of people lease cars because that works for their financial situation (and there is nothing wrong with leasing a car if that’s the right option for you), but what I am trying to do is get you to realize that you have to evaluate all of your options before making any financial decision.  Regardless of how short a period you are considering, or how little money is involved, if you aren’t evaluating all of your options, which includes looking at the numbers, you’ll have a hard time making the right decision. 

As I discuss in my book, by the time I was 22 years old, I had owned seven different cars – I constantly made decisions without looking at the numbers – I made decisions based on wants instead of needs.  This resulted in me losing a ton of money on these cars because I made emotional decisions instead of factual; if I wanted a new car, I went and bought it, because at the time I had the means.  I never thought about the future, so I made bad decisions which impacted me for several years.  Instead of spending all that money on cars, I could have saved it and built myself a small nest egg to put towards a down payment on a house.  At a young age, you have the opportunity to make some really good decisions to set yourself up for financial success in the future, take advantage of this opportunity and the next time you’re thinking of buying a car, make sure you evaluate all of your options, whether it is leasing or buying a new or used car, make sure you do your research, evaluate all of your options, separate your needs from your wants (you might need a car, but you probably want that sexy new sports car), and make the decision that will help you meet your financial goals.

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