I've said over and over again that savings rate is the most important metric to follow if you want to become financially independent and retire early. Unfortunately though for many, calculating your savings rate can become a chore that you might do once a year. If so, it's difficult to affect your behavior in a meaningful way.
Want to take a short cut π: free budget and expenses tracking Google Sheet.
I realized I had fallen for that same trap myself and realized I need to do better to really hit my target of retiring at the age of 40. I need to manage my expenses.
I've seen my annual expenses climb the last three years
- from 26,477€ in 2018
- to 29,814€ in 2019 - up 12%
- to 31,942€ in 2020 - up another 7%, almost +20% from 2018
It became obvious to me that this rate cannot continue. If my expenses would continue to grow 10% annually, how could I ever become FIREd?
Using my Financial Independence Calculator you can easily check how much the net-worth goal escapes away from you if you keep increasing your monthly expenses. Adding 20% to your expenses means your net-worth goal is also 20% increased. That's a big difference if you're talking about e.g. 1,000,000€ vs 1,200,000€.
And not just that. Imagine what the effect is in years! If you start with 30,000€, have a net income of 2,800€ and save half of it with 7% interest, you'll be retired at 60 with 600,000€. If instead of 1,400 monthly expenses you spend 1,700€, you'll have to accumulate 729,000€ and you'll reach that by 68! Eight. More Years.
It all boils down to your savings rate. Whatever that is, it will dictate the length of your journey.
Savings rate is about two things: income and expenses
As we know, savings rate is the factor of two things: your income and your expenses. By substracting your expenses from your income, you get your free cash flow, i.e. the amount of cash left over to invest every month. The proportion of free cash flow to your income is your savings rate. Simply put:
Master that and you're set. If you can hold a savings rate of 50%, you're in the top 30% and have a great chance for reaching FIRE.
While affecting your income might be hard and take time, managing your expenses is something you can do immediately. The first thing to do though is to start following them, create a budget and stick to it. I'm going to help you do it.
Manage your expenses by budgeting
In order to get your expenses under control, you need to budget. In order to budget, you need to have a good grasp of where your money is going and proactively start influencing your spending habits. I've created an easy, free Google Sheet for you to do that and here are the steps you need to take:
1. Set a baseline
You should start first by setting yourself a spending baseline. You can do that by looking at your expenses for the last month (or even better, a few previous months) to see where your money is going. You'll need to categorize these expenses, at least at high level, in order to not become overwhelmed with individual transactions. Here are the categories I use, with average monthly spends from last year:
- Housing, 633 €
- Food, 482 €
- Traveling, 428 €
- Car, 396 €
- Services, 342 €
- Shopping, 292 €
- Hobbies, 238 €
- Insurance, 121 €
- Investing, 92 €
- Utilities, 70 €
- Wellness, 36 €
- Leisure, 35 €
You can use those or come up with your own expenses. I would recommend leaving out income-tax kind expenses from these and use your net income (post-tax income) to account for that. It makes things easier, since that's unlikely a tax you will need to pay anymore once you're FIREd.
You should also use subcategories under the main categories to help see fluctuations in certain behavior. E.g. I have now grouped groceries, lunch coupons and restaurants under food, but if I see an increase in food costs, I want to be able to see if it's because I'm eating out more.
2. Budget monthly
Once you know your baseline and understand where your money is going to, create a monthly budget. The baseline is a good starting point, but especially if you need to cut down on something (again using restaurants as an example) account for that and adjust your budget accordingly. Here's what my budget could look like for this year:
If you get this far, you've done most of the preparations. Congrats! And now we get to the real beef, which is tracking your expenses monthly.
3. Track your individual expenses
To do this well, you need to be able to track everything you spend on. It's easier if you pay for everything with a card, debit or credit - doesn't matter. Your online bank should be able to provide you with all the transactions. After that, it's simply a matter of going through those transactions periodically.
The best format to save your transactions is following:
| Date | Amount | Category | Subcategory | Method |
|---|---|---|---|---|
| 2021-01-05 | 80 € | services | cleaning | debit |
| 2021-01-07 | 48 € | utilities | electricity | debit |
| 2021-01-08 | 20 € | food | restaurants | credit card |
| 2021-01-08 | 51 € | food | groceries | credit card |
| 2021-01-11 | 2 € | car | parking | credit card |
The reason you want to track also the method of payment is because as you update your expenses later, if you source that information from multiple places, it helps you keep track of which items you've already processed.
For example, if you look at your debit expenses, you can filter your list to the last debit expense you have recorded and compare that to your actual transactions from your bank. Items before that you've probably already processed and anything after you still need to add to your tracking. Just keep it consistent so you don't miss anything.
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