Management guru Peter Drucker said “If you can’t measure it, you can’t improve it“. So in order to take control of your finances, you first need to know where your money goes. I know a guy who thought he was saving about $200 per month. He wasn’t actually tracking his expenses, the $200 savings was just his best guess. After a couple of months of actually tracking his monthly expenses, he found out he was actually losing $300 per month! Don’t be this guy.
There are many approaches to budgeting and staying on top of your finances. We actually don’t budget in the sense that we don’t keep a limit on how much we can spend. Instead, we use a simple 2-step process to stay on top of our finances:
Step 1 – Think Purchases Through
I use the following thought process before making any purchase:
It leads me to avoid unnecessary expenses and expenses that won’t make me happier. Let’s go through a few recent real life examples of how I used this chart.
- Rear light bulb replacement for my car – Do I really need this? YES, I don’t want to be get pulled over. Where can I get it at a low cost? Spend a few minutes online comparing prices, choose one and done.
- Brand new car – Do I really need this? NO. Will it increase my long-term happiness? Hmm… It will make me feel good for a couple of weeks, maybe a few months. After a while, hedonic adaptation will work its magic and I will be as happy as I am today with my current car, except it would set me back thousands of dollars and delay financial independence. DON’T BUY.
- Dining out with friends or buying plane tickets to visit family overseas – Do I really need this? NO. Will it increase my long-term happiness? I believe that spending quality time with friends and family, and strengthening those relationships brings lasting happiness, so YES . Can I get the same thing for less somewhere else? At this point I have decided I am going to buy, so now it’s just about seeking the most bang for your buck (look for cheap flights, suggest inexpensive restaurants, do some travel hacking, etc).
Before you buy any product or service, you can quickly go through this thought process. It will keep you from making unnecessary purchases you will regret later.
Step 2 – Track Expenses
At the end of the month, I log in to my Personal Capital account where I can access all my financial transactions in one place. Besides seeing all your income and expenses in one place, Personal Capital allows you to track your net worth and analyze your investments. You can join Personal Capital for free!
After accessing all my transactions through Personal Capital, I classify them into different categories (housing, groceries, gas, etc.) using this spreadsheet. The entire process takes about 15 minutes, and you get a clear picture of where your money is going. You work hard for your money! Make sure you know where it is going, and whether the things you buy are worthwhile or not.
Where Did Our Money Go In 2015?
2015 was an exciting year for us. We got married, traveled overseas twice, had family visiting from Colombia, and I started grad school. It was also the first full year Elisa and I lived together, and the first full year of tracking our expenses the way we currently do. Without further ado, here is a summary of where our money went during the year. I sorted it from highest to lowest to see what categories consume most of our money.
Savings: the most important item for us and for anyone who is also pursuing financial independence. We were able to keep it at over 50% despite having only one income. We are aiming to increase our savings rate for 2016 and will post an update at the end of the year (so far so good).
Rent: this is our biggest expense so we are exploring ways to reduce it (without reducing long-term happiness). We are considering the possibility of buying a home that makes sense financially. The rent vs buy discussion is a very interesting one, I plan on writing a post about it soon!
Supermarkets: includes groceries and occasional non-food purchases such as toiler paper, paper towels, cleaning supplies, etc.
Travel: includes plane tickets and hotels, mainly. I recently started looking into travel hacking to lower the costs while keeping the fun of traveling. So far, Elisa and I were able to book round trip tickets from Raleigh to Seattle for $24! (I’ll probably write more about it in the future, as of this writing I am still a beginner).
Others: includes anything that doesn’t fit into the other categories. Some of the major highlights for 2015 include an overnight package we had to send to Colombia for $110 (ouch!), some Ebay selling fees, and other “small” stuff that adds up.
Education: some grad school fees and textbooks. So far I have been able to recover some of the textbook costs by selling them online.
Seemingly small expenses add up! The best example of this is my “others” category. There were only a few major items here, yet the total was about $1,700! I am experimenting with adding notes to my spreadsheet to have a better picture of what’s going on here.
Even though I have been optimizing expenses for a while, there is still room for improvement. For example, we recently switched cell phone providers and car insurance companies. Both are saving us money and will continue to do so. Housing and travel costs are two places we are just starting to look into, and we should be able to reduce those over time. If you have never looked at your finances closely, chances are you have huge opportunities for improvement!
“Life decisions are not always about money, but you better understand the money part of your life decisions.” – Unknown