If you want to make it to Early Retirement or Financial Independence, you absolutely must know what your spending is. Tracking your expenses is the only way to gain a holistic view of your spending habits.
I I have said before, tracking is not budgeting. We are “toughening up, cupcake”, avoiding the excuse to spend and not using mental crutches to curtail our bad habits.
For a family which has never tracked expenses before, this exercise can be painfully enlightening. Carried over several months and years, your recurring expenses drill a painful hole in your wallet. Tracking helps spotlight wasteful spending and encourages you to stop spending or substitute more frugal options.
How much do you really need per month to sustain your lifestyle?
For the advanced FIRE family, consistent tracking is the only way to estimate how much money it will take to retire. If we take as a given that a family may retire when their investments are large enough to cover their expenses, we must first determine their expenses. Taking monthly spending and multiplying by 12 gets us annual spending. Multiplying annual spending by between 25 and 30 gives us our investment goal for regular retirement. If you plan on early retirement, say, longer than 30 years in a retired status, it would be better to assume a lower withdrawal rate.
Note: If you plan on early retirement, say, longer than 30 years in a retired status, it would be better to assume a lower withdrawal rate. The oft-quoted Trinity Study suggests a 4% withdrawal rate is safe over 30 years, hence 25 X Annual Spending. The excellent bloggers at Early Retirement Now have done longer time horizon research which convincingly suggests a safe withdrawal rate is probably more like 3.25%, at best.
Military Note: Are you counting on a pension? Make it to 20 years and the pension may cover a good deal of your expenses in retirement, reducing the size of the required nest egg. Run the numbers both ways.
There are lots of automated apps out there, MINT, USAA, YNAB etc. I have found manual data entry to be the best for me. None of the Apps really offer enough flexibility, and since I’m constantly playing with ALL the numbers in my spreadsheet, I like to control the data too.
THE PROCESS of TRACKING
Every time we have an expense, I email myself. Every. Single. Time. I break down our Fixed Expenses by my preselected categories. Monthly totals are captured on the main sheet. These include Rent, Loan payments, Taxes, and Charity.
Discretionary, or Non-Fixed, spending, like groceries, household consumables, eating out, and hobbies are further broken out into a more detailed spreadsheet. I do this to avoid cluttering the Main Sheet. Sometimes I run experiments in this sheet. For example, groceries used to encompass food, paper towels, and shampoo. I found that I liked seeing the data on just food, so I separated household consumables from the groceries category. This also allowed me to see just the grocery bill at a glance, on the main sheet.
Below are our actual Non-Fixed expenses for January 2017. Note the spreadsheet is “frozen” so not each day is visible in this snapshot view. Daily totals are summed under each collum, category-monthly totals are summed in the rows to the left.
I use color codes to even further break out our expenses. On the Non-Fixed tab, Yellow items are a “one-time” expense. We are expecting a baby, which entails a lot of start up costs. Since we will only need to buy some items, like a Crib, once, even if we have subsequent children, I am marking these items for future research. By differentiating between recurring, non-fixed, and one-time expenses we have a powerful data set which will help us in the future. I don’t plan on obsessively tracking every penny for all time. If we have another child, I will be able to get a good sense of how much we will spend above the normal during the pregnancy, during the first year, etc. By subtracting out the one time purchases, we will have an accurate look at how our expenses will change for the future. Powerful stuff if you front load investments and debt paydown, or are planning a big expense.
This method is endlessly scalable. For our purposes now, it is enough to say we spent $85 on baby goods this month. In the future, I might set up a sheet to capture exactly the cost of the baby, including categories like Diapers, Food, Childcare, Clothes.
We also track the individual gallons of gasoline we use. Because this commodity is so volatile, knowing the historical dollar amount spent on gas for any given month is useless for future planning without a historical price. With the gallons expended, we can quickly predict our cost using current gasoline prices. This will be useful if gas goes up to $5/gal again. I would do this for any frequently bought, difficult to store, highly price volatile commodity. Some items like Diapers and Rice store well and are best bought in bulk when prices are low. This is hard to do with things like Gasoline, heating oil, and beer. With these ‘use it or lose it’ items, its best to be able to forecast your usage and adjust spending elsewhere or do with less rather than risk losing product by overbuying and letting it spoil.
What To Do with the Data
Using this data is simple. Add up all your expenses. Add up all your income. Subtract the out from the in. As Jim Collins says- “Invest the Rest”
If your number is negative, you are spending more than you earn. Reduce wasteful spending, seek more income. Get your Side Hustle on!
Some useful functions of tracking:
Once you have all these numbers, it gets a lot easier to answer some of the tough financial questions like “How much do we need to retire?” and “what is our monthly savings rate?
- Monthly Spending = All expenses EXCEPT: Taxes, Savings, Retirement Contributions
- FI Investment Goal = Average Monthly Spending X 12(months/year) X 25, 30, or 35
- Pre-tax Savings rate (shoot for >50%) = (Savings + Retirement Contributions + Debt Pay down ) Divided by Pre-tax income
Using the Past to Shape the Future
No, not like Doc and Marty. Once we know what each month’s spending looks like, we can efficiently deploy our resources. For example, I know that we need to buy heating oil every 2 months or so in the winter for a cost of about $300. Rather than trying to save for the eventual oil bill, we can just reduce my extra loan payments in the month we expect to buy oil, maximizing (and frontloading) our loan paydown in prior months.
Looking forward from month to month it is also possible to do your taxes in advance. Since you know your spending and earnings, you can appropriately spread your retirement contributions and other tax-advantaged monies in a way to take maximum advantage of the tax code and front loading. Instead of guessing if you should contribute to a Roth or Traditional IRA in November, you will know. You could know in January. This avoids having to wait until the next January to suss out IRA contributions, potentially missing out on market gains or overpaying your taxes.
For a great post and discussion on front-loading go see the Doctor.
I’m not a budget guy. You will note that none of my “Non-fixed” categories come with a pot of money which we expect to spend. Taxes, rent, and insurance are things you budget for since they happen every month. If we needed to we could go without spending money on gasoline this month- we don’t try to meet our spending goal, but we track what we did spend so we know what we are likely to use in the future. I can’t stress this point enough. If your goals are to eliminate waste and invest in an efficient manner, tracking is the way to get there. A Budget is a spending plan- run away!
Are you a hands-on data diva, or do you use one of the online trackers? Can you recommend a daily expense tracker to us that does a great job?
Disclaimer: I am not a Financial Advisor. These opinions are my own and are not endorsed by the US Government.
I use Personal Capital to track our net worth. Its a great tool to visually manage your funds, plus it has a great retirement planning simulator. Its not for everyday tracking of expenses, but it helps me manage our finances all from one place. If you are interested, click on the link below. You will also be supporting this page!