“JM”, a new commenter on the blog, left a great comment asking about tracking spending and how that helps you get to Financial Independence.
“Do you track all your monthly spending, no matter how minute? Did this help get you to Financial Independence? And how?” -JM
I wrote a detailed reply to JM but I wanted to elaborate a bit since expense tracking is so important.
The quick answer is yes, I did track all spending down to the dollar while working towards FI. And looking back, tracking everything I spent was pivotal to accelerating my journey to FI.
A quick note: I’m not talking about budgeting here. I never budgeted before I got to FIRE. I’m only talking about tracking spending. Knowing how much you spend each month broken down by specific expense categories.
Why Track Spending?
I hate wasting time on pointless tasks just because conventional wisdom says “hey, you gotta do this because it’s important”. I view personal financial management as an overhead cost to living a good life and not something that’s intrinsically valuable in itself.
But tracking spending isn’t a waste of time at all. Here are four key reasons to track spending:
- When you know how much you spend each month you can plan your cash flow better.
2. Detailed expense tracking lets you focus on problem spending areas which can free up more funds for saving and investing.
3. Tracking expenses ensures transparency and discussion in couples’ finances
4. Knowing what you spend each year leads to better spending projections in retirement. That means a fine tuned portfolio target size.
Track Spending to Plan Cash Flow Better
After talking to dozens of people in my early retirement lifestyle consulting sessions, I realize that those who know how much they spend tend to be way ahead of the game and have a good handle on their general financial planning, even if they are missing a few details.
When you know what you’re spending you can identify the portion of your income that you DON’T routinely need and save it automatically. If you aren’t maxing out your 401k or IRA, you might be able to afford it if you actually knew how much of your income was required for routine monthly expenses and how much could be devoted to savings goals.
Knowing what you spend can give the confidence to make other money moves, too. For example, refinancing from a 30 year mortgage to a 10 or 15 year mortgage to score significantly lower interest rates might be possible if you can accurately identify how much of a surplus you have each month in your cash flow.
Track Expenses to Eliminate Wasteful Spending
I’m not a fan of budgeting but rather a fan of looking at where you naturally spend your money. Then periodically reviewing actual spending results versus your values. If you’re spending $500 per month on dining out and you get a huge value out of dining out frequently, then by all means do what you love.
But if you find out you’re spending $500 per month dining out because you’re too lazy to go to the grocery store and occasionally cook things in your own kitchen, then perhaps that’s an area of spending where you want to trim the fat (so to speak). Staring at a $500 expense every month that could be $100 will hopefully lead to positive financial changes.
Tracking your spending lets you compare how much you spend in each category and evaluate the relative benefits you see in each category. You may find several hundred dollars per month in small expenses (coffees, convenience store impulse grabs, “treats”, membership fees to places and services you no longer patronize) that you don’t value very highly. Money is tight and you can’t afford to take a proper vacation. Novel idea: redirect the hundreds of dollars per month of small spending toward one or two vacations each year!
The point of expense tracking isn’t to identify all discretionary spending and cut those categories to zero. Instead, you look at the data and get to decide for yourself whether you’re spending money on what you value. Because what you value isn’t necessarily what I value and isn’t what any personal finance guru values. Don’t listen to them; listen to yourself and focus spending in areas that bring you the most value.
If after looking at your spending you notice some categories that don’t bring value at all then focus on decreasing spending in those areas. Divert the savings toward your investments and retirement accounts. Future you will thank current you.
Track Expenses to Ensure Transparency and Discussion in Couples’ Finances
For those married or in a relationship where you share finances, tracking spending keeps you honest. Discussion on spending choices and priorities will happen. This doesn’t mean you will agree on everything but at least the raw data will be there in front of you and open up discussion (and screaming and yelling??).
Detailing the best method to manage couples’ finances is beyond the scope of this article, but keeping track of what you spend as a couple is a key ingredient. Some adopt the “his/hers/ours” approach where each partner has their own funds and contributes to the common pot for their common expenses like groceries, house payment, and utilities.
It gets tricky if only one spouse is aiming and saving for financial independence. At a minimum, that spouse should track their own spending plus the joint spending pot of money to see where the money is going.
In our house, we had joint financial accounts for everything. I was in charge of managing those accounts and tracking spending. Discussion time usually happened once per quarter where we reviewed overall spending and areas of abnormally high spending.
Know What you Spend Now So You’ll Know What You Will Spend In Retirement (and Plan For It!)
If you’re planning on using some variation of the Four Percent Rule which says you need 25 times your expenses in retirement, then you need to determine what those expenses in retirement will be.
The best way to determine what you will spend in retirement is start with the baseline spending patterns you have right now. Add to that new expenses in retirement (taxes, health insurance, more leisure and travel) and subtract those expenses that will decline or go away (commuting expense, work wardrobe, lunches out with coworkers).
Before I started tracking my spending, I mistakenly thought I was spending more than I really was. When I tracked expenses accurately, that let me reduce my retirement savings target by several hundred thousand dollars. A lower savings target equals retirement at an even earlier age!
To illustrate the big problem with poor expense tracking data, let’s look at an example. If you think you are spending $60,000 per year and want to continue that level of spending in retirement, then you need $60,000 x 25 = $1,500,000 to retire early using the 4% rule.
But whoops! You’re off by $10,000 and actually spend just $50,000 per year. Suddenly your savings target declines to $1,250,000. That’s an instant $250,000 “savings” that comes from accurate spending data which means retirement is potentially several YEARS earlier.
In contrast, if you underestimate your current spending by $10,000, thinking you only spend $60,000 per year, then you have an even worse problem. If you actually need $70,000 per year in retirement and you only save $1,500,000 ($60,000 x 25) then you are a quarter of a million dollars short in your retirement savings! Time to work several more years or slash your spending.
You can’t determine your future spending without a detailed account of your current spending. So get to tracking!
How to Track Spending
We have explored the “why” of tracking spending. Now let’s switch course and look at the “how”.
It doesn’t really matter how you track spending. Just find a system that works for you and your lifestyle and do it! And do it fairly accurately. If you’re missing hundreds of dollars of spending every month, your spending data is better than nothing but not that valuable.
I tracked expenses for the first several years with a spreadsheet. At the end of each month I copy/pasted the transactions from my credit card statement and checking account into a spreadsheet. Then I categorized each transaction manually. The spreadsheet tallied each category of spending for me.
My spreadsheet had 24 categories:
2. House – repairs/maintenance (incl. appliances/repairs)
3. House – insurance/taxes
6. Utilities-Cable TV
7. Home Furnishings/Furniture
8. Communications – Phone/Cell Phone/Internet
13. Groceries/Household (Walmart, Target, Grocery Store)
14. Student Loan Payments
15. Education/Training/Prof Fees
16. Childcare/Afterschool care
17. Dining out
18. Entertainment/Toys/Fun (incl. ABC store)
The spreadsheet was a great solution for a money nerd like me that wanted to track everything in an infinitely customizable and detailed method. The downside is it takes a good bit of time given the manual data manipulation required in the spreadsheet.
I don’t have a link to my spreadsheet because it’s fairly rudimentary and kind of a mess. I built it for me, not the masses! And maybe you don’t need 24 expense categories like I did.
I tracked my expenses in detail using the spreadsheet for about six years total. Around two years after retiring early, I realized I no longer needed to track every single dollar in exact detail. It was evident we were on track financially to spend within our $40,000 retirement budget and I could “fudge it” by ignoring the very few small cash transactions I conduct each year. Almost everything we spend goes on a credit card, so 99 point something percent of our spending data is already in electronic format.
How to streamline things and save time? Personal Capital was the answer for me (it’s free). Others use Mint or You Need a Budget with great success. I don’t have any experience with the latter two solutions so I’ll share what I know about Personal Capital (and you can see a more detailed review here).
In a nutshell, you link your accounts in Personal Capital and it downloads all your transactions from credit cards, debit cards, and checking accounts (including ATM withdrawals = a way to track cash expenses in granular form). Personal Capital tracks all your investment accounts too. You can access your expense tracking through a web-based interface or through an app on your phone or tablet. And hey, it’s free.
Instead of spending an hour doing my copy/paste/sort/classify/copy/paste dance in my expense tracking spreadsheet every month, I now spend about ten minutes poring over my data in Personal Capital. It’s easy now. I read through a couple pages of transactions just to make sure they are categorized correctly by Personal Capital. 90% are correct. The other 10% I have to manually switch the category.
For example, Personal Capital thinks Walmart is groceries for me since that’s usually correct. But sometimes it’s primarily clothing or automotive or general household goods.
A couple of downsides with Personal Capital: there’s no way to enter a manual transaction, such as spending cash. I overcome this by classifying ATM withdrawals as whatever I generally spend the money on. I rarely spend cash other than when traveling. For this reason, ATM withdrawals are almost always categorized as “travel” in my record keeping.
The other downside to Personal Capital is the inability to split an expense into two or more categories. Going back to Walmart, I might spend $16 for a new pair of windshield wipers and a quart of motor oil, $9 on a new ten pack of socks, and $75 on groceries. In my rush to spend as little time as possible micromanaging my money, the transaction becomes a $100 grocery purchase instead of $16 “automotive” / $9 “clothing” / $75 “groceries”.
This is close enough for my goal of tracking the total dollar amount that I spend each year, even if a little bit of detail is lost in the aggregation of the data. So my categorized data is somewhere around 95-99% correct at year end versus 99.9% correct if I use a spreadsheet. In other words, good enough for my purposes. And it’s easy enough that I still devote the minimal amount of effort required to continue tracking expenses consistently for the past several years. I stopped updating the expense tracking spreadsheet a few years ago because it took too long.
But maybe you need something more accurate if you’re just starting out on the path to FI and want 100% accurate spending data.
If you are interested, you can join Personal Capital for free right now. Note: that’s an affiliate link and Personal Capital may compensate me if your account meets certain conditions.
Looking back at my path to Financial Independence, tracking every dollar I spent was critical. I knew where my money was going and over time I squeaked out additional savings which led to an increasing savings rate in my last few years of working.
Tracking spending comes with four main benefits:
- Knowing how much you spend leads to better month to month cash flow management
2. Tracking spending by category identifies areas where you spend a lot of money and tells you where cutting costs will have the most impact
3. Tracking expenses ensures transparency and discussion in couples’ finances
4. Knowing how much you spend is key to developing an accurate forecast of retirement expenses (which is an intermediate step to calculating a retirement savings goal!)
Are you tracking expenses now? How do you keep track of your spending? Has it led to any cost-cutting in certain spending categories?
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