The question I get most often regarding personal finances is ” I want to acquire X (with X being a new house, a new car, a new gadget, etc.) or I want to do Y in the future (with Y being paying off debts, saving for X, etc.); how do I set about getting my finances in order to do this? Most of my response to this question was to go over what their financial situation is, set up some sort of budget, give them some advice, and send them off with the hope that they would implement my advice so they could do X or Y. While of that is well and good, the problem lies in that in solving for X or Y, we didn’t talk about Z, which is the source of why doing X or Y is hard. This led to the person coming back to me saying, I did what you said, but I still don’t know if I can acquire X or do Y. So now, I talk about Z. For most people Z is controlling expenditures.
Now you may think that controlling expenditures is an easy no-brainer when dishing out personal finance advice, but I would say that it is one thing to set up budget for an expense line item and tell yourself that you are not going to spend more than what you have in the budget, it is another thing to actually stick to it. At its best for most people, a budget is a historical expense tracking tool. Thus, it is easy once you see what you actually spent to totally miss your mark on your budget. Unless your budget can physically stop you from spending money, the budget won’t help you truly control expenditures. To truly excel in controlling expenditures, you need to change your mindset on how you spend money. To help you with this I will be spending two blog posts discussing ways to help in controlling expenditures. The first way….
#1: Stop Spending Money
As Bob Newhart says in the video above, Stop It!. That may seem completely obvious and you can’t just not spend money, however, the problem lies in that our level of expenditures are usually pretty tied into the amount of money we make. This means that the more money we make, the more we spend. So if you are someone who is making $50,000 a year in after tax take home pay, and you spend $48,000 and save $2,000; when you get a raise to bring your take home pay to $60,000, instead of spending $48,000 and saving $12,000, you most likely are raising you expenditure level proportionally and spending $57,600 and saving $2,400. Most Americans expend money based on their income level (or worse, more than their income level). However, our expenditures should not be tied to income and rather stay the same or decrease over time as debts are paid off.
Simply, the answer to this is to stop spending money. Figure out what are the base level expenditures you need to live on and stick to that. You will be surprised at how little that actually is and conversely, how much money you waste spending above your base level. Based on the Department of Labor, the average base level expenditures for a family of four (not including rent/mortgage) is $33,961 for an income before taxes amount of $65,132 (about $52,000 after taxes). For most families of four, this base level expenditure (not including rent/mortgage) should be around $20,000-$25,000, if not lower and this is regardless if you make $40,000 a year or $400,000 a year. That is not a typo. So how do you get there?
- Think of your spending in annual dollars, not monthly dollars. The reason for this is twofold. One, you typically think of your income in annual dollars (i.e. I make $50,000 a year). In order to proper compare your spending to your income, you should compare apples to apples. The second reason is thinking in monthly dollars makes the expenditure seem less of an issue than it is. A $75 a month cable bill may not seem like too much, however, over a year that results in an expediture of $900 or approximately 2% of your annual income (using $50,000 as an example). Do you want to spend 2% of your annual income on one item?
- Break out your expenditures into three categories. The first category is fixed expenditures. These are expenditures that are going to be the same from a month to month basis and are going to be continual throughout the year. An example would be a loan repayment or a gym membership. The second category is your fixed variable expenses. These are expenses that occur on a month to month basis but vary as to the amount. An example of this is your utility payments like gas or electric or your groceries. The third category is variable expenses. These are expenses that happen irregularly and when they do, vary as to the amount. An example of this would be a doctor visit or clothing purchases. The key is to make systematic expenditure reductions in each of the categories. For fixed expenditures, are the items that you can outright remove (maybe a gym membership) or reduce (getting rid of cable and replacing it with Netflix or HuluPlus)? For fixed variable, are there ways to reduce what you spend (buy groceries in bulk)? For variable, are there ways to extend the time between expenditures (buying only clothes when you truly need them, rather than want them).
Those are just some places to start in controlling expenditures. In all fairness, I am not where I need to be in controlling my expenses, although I am getting close to being in the range I discussed above. In my next personal finance post, I will discuss some additional ways for controlling expenditures that will hopefully allow you to save more and better your personal finances.