How much a person needs to save in order to retire is the most common question when it comes to financial planning. In order to really answer that question accurately, you need to know how much you spend.
Most people know how much money they make on a yearly basis. Fewer people know how much they spend. This is the more important number to know. In knowing what your expenses are, you can better plan for your financial future.
When you manage and limit expenses, you increase the speed at which financial goals can be obtained. If you know what your expenses are you are in a stronger position to know how to reduce them. In this post, I discussed how having less ‘stuff’ may actually make you feel better. Happiness comes from someplace other than spending.
Today, I will discuss how to answer the question, “How much do you spend?” In the subsequent parts of this series, I will show how this is a great starting point for effective financial planning. Once you have determined how much you spend you can better determine how much you need to save.
It’s not how much money you make but how much money you spend that really counts. So why not start tracking what you spend?
Life of a New Lieutenant
When I graduated from college I was very lucky. Between my parents and the Army, the cost of my college education was paid for. I was also lucky to be on the payroll of the Army immediately after graduation. When I arrived at Fort Knox, KY, for my Officer Basic course as a newly commissioned Lieutenant, I had virtually no recurring monthly expenses. In addition to my salary, the Army covered the cost of my apartment and paid me a food per diem while attending my initial training.
I can remember getting my first paycheck. The net was about $900. After being a college student, this seemed like a lot of money. 15 days later I got another $900 check and then much to my surprise I got another $900 per diem check. Holy cow – I was rich! As a 22-year-old Lieutenant with virtually no financial obligations, that money would go a long way. I would save a great deal of it.
Even though I wasn’t making a lot of money, having a low overhead magnified that money. Focusing on reducing your overall expenses will allow you to achieve financial excellence at a faster pace.
Let’s Make A List
This is not a post trying to make you feel bad for not having a budget. If you or your family doesn’t have a budget, you should at least be tracking what your monthly/yearly expenses are. If a budget is tracking where your future money is going, tracking your expenses is like understanding the past. Once you answer the question, “Where did my money go?” you will be able to adjust from there.
The good news is that by doing this exercise, it will be much easier for you to create a future budget.
A few quick steps
1. Start with your paycheck! Pull out a paycheck and start identifying all the expenses that are being deducted before and after taxes. It should look something like the below.
2. Next identify all your monthly, semiannual, and annual after-tax expenses. When I first did this, I found the best way was to go online to every financial institution I use and pull a few months of statements. Some banks have budgeting software already pre-populated.
3. Make a list of those expenses with the monthly and yearly totals. I use Microsoft Excel. If you have a credit card or debit card where things like gas and food are accounted for, consider using a 4-month average of that expense.
4. Lastly, you will need to list all of your after tax savings, investing, and debt pay down. The debt pay down is any extra payments you are making against items such as student loans or a mortgage. These items should be separate from your expenses.
What you should have now is a tally of your gross annual salary with all the deductions accounting for every dollar spent and saved on a spreadsheet. You might not be able to account for everything. That’s ok. You should be able to quickly pull a list together and come up with a 85-90% solution. A little more work will get you a bit closer.
If still not 100%, we call this in the Government, ‘good enough.’ The lesson learned is much the same.
Now that you have your list of expenses, you know how much it takes for you to cover the cost of living on a monthly and annual basis, and more importantly, you can identify which ones to go after and try to eliminate or reduce. Of course, some of your fixed expenses are harder to eliminate or reduce unless you do something radical. And shipping your kid off to grandma’s isn’t an option here. But the more optional expenses (recurring fees, memberships, dining out, car payments) can be focused on.
With this information you are now better prepared to start planning. Also with this information, you might just be less inclined to buy something new that comes with a monthly payment!
In part two of this series, I will address how to answer the question you hear all the time: How much do you need to save?