In this series of posts, I’m going to teach you how you can build a strong financial life while still enjoying the things you love most like traveling & living where and how you want to. I’ll also talk about how I did it, showing you step-by-step what you can do in your own situation.
Part I – Create a spending plan that meets your needs
A lot of personal finance websites emphasize frugality as the sole means to financial well-being. They come replete with tips like “don’t accelerate too quickly to save on gas” or “buy one-ply toilet paper.”
I believe that for most people, these tips are not worth the effort to implement, nor are they the key ingredients to a healthy financial life. So…
Here’s how YOU can take control of your finances (Hint: Take action today; if you don’t, stop reading my blog, it can’t help you.)
Step 1) Put a copy of your most recent paycheck in front of you. Write down how much you make in monthly gross income (take your pay and multiply by (26/12), or 2.167, for those with biweekly salaries.)
Add in any bonuses you expect to receive, or any income you make through other sources (baby-sitting on the side, unemployment benefits, drug-trafficking etc.) Since you’re reading my blog, I’m going to assume you’re not retired, and thus aren’t getting social security checks. I’ll also assume you’re a working stiff that relies mostly on your own earned income, and are not cashing in investments (but if you are, count these too, plus any sweet trust fund income that Daddy set up for you, you spoiled bastard.)
Step 2) Get a rough, back-of-the-envelope calculation on how much you spend. This step takes the most work, but it’s also the most important; you need to know where your money is going to take control of it! I recommend an excel template like this one to track this info (combine, leave blank/delete and modify items to fit your situation. Use the ‘Actual Cost’ columns for expenses; later, we’ll use the ‘Project Cost’ columns for what you’d like to spend.)
The steps below are in order of increasing difficulty. If you’re too lazy to go through the 4 sub-bullets, at the very least, fill in your biggest expenses and give a rough estimate to the rest.
- Since you already have your paycheck in front of you, calculate the expenses that come straight out of this: health insurance, other insurance like voluntary disability or life, federal/state/local taxes, and anything else. For those with biweekly income, figure the monthly expense of these paycheck deductions by taking your biweekly paycheck’s deductions and multiply them by (26/12) or 2.167. This is your monthly expense (which is pretty accurate assuming you don’t owe much or get a large tax refund at the end of the year.)
- Calculate easy-to-track expenses like rent/mortgage and any other monthly or annual payments you make (internet, cable, cell phone plan, student loan payments, car payment, Netflix, magazine subscriptions, car or life insurance.) Of course, for annual/ semi-annual/quarterly expenses, you’ll need to divide by 12/6/3 to get the monthly expense.
- Estimate the regular payments that aren’t always the same amount each month (like utilities, or gambling losses funneled to your bookie.)
- Estimate how much you spend on irregular items like groceries, eating out, clothes, entertainment (going out to bars/clubs, movies, CDs/DVDs), travel, gifts, and charity. Also, create a miscellaneous category to lump together hard-to-track or infrequent purchases. Look over your 3 most recent monthly credit card and bank statements to give you more accurate information and bring items to your attention that you otherwise might have forgotten. Crunch some of that data to give yourself a monthly average of expenditures based on the reality shown in those statements (which should be available online.) When you look at the hard data of what you actually spend, you’ll be surprised at what’s costing you an arm and a leg. I certainly was the first time I did this.
Step 3) Subtract your expenses calculated in 2 from your gross income in 1. Hopefully, your expenses are less than your income. If so, congrats, you’ve achieved the first rule of personal finance: ‘spend less than you earn’. Also insert into the equation how much you’re investing in your 401k, money market fund, savings account, etc. For kicks, you can divide that number by your gross salary to see what percentage of your income you’re currently socking away. (Depending on the number, you’ll likely want to increase that percentage to meet major goals like retirement, paying for a wedding, buying a car/house/Jackson Pollack etc. Don’t worry about that now, we’ll talk about that in a future post.)
Step 4) Look through your expenses for areas where you are spending more money than you’d like to. This means writing down what you’d LIKE to be spending in each category, and comparing this with what you’re ACTUALLY spending. If you’re using the recommended spreadsheet, fill out the ‘Projected Cost’ column with your budgeted numbers. The goal here is to cut spending on areas that don’t really add much value to your life.
If you’re not sure about what number to use for a given category budget (“is $200 per month reasonable for going out to eat?”), don’t sweat it too much; just put something down that seems reasonable to you. If you want, you can break it down by units of consumption: i.e.: “If I want to go out for lunch three times per week, and I usually spend $10 each time including tax & tip, that’s about $30 per week and about ~$130 per month (= $30/week * 52 weeks/12 months.)”
Be honest with yourself
Think about what you enjoy doing most with your time and money (or what you wish you could be doing with more of each.) Then, resolve to cut things that don’t matter as much to you. Here’s a great article by Ramit Sethi on this idea of getting your finances in order and focusing spending on what matters to YOU (rather than what other people spend, or what they think you should spend.)
Now that you’ve tracked your spending & set up a budget, you’re ahead of 95% of people in terms of understanding & managing your money. In the next post, we’ll cover how to automate your savings & spending to set up an emergency fund, pay off debt, and invest simply and smartly for the things & experiences that you want out of life.