If analyzing your low or negative monthly cash flow causes you an inordinate amount of stress, your (correct) instinct may be that it’s time to dial back your expenses.
To do this successfully, you need to understand which expenses are putting the unnecessary strain on your budget. Do you have an excess of food and entertainment expenses that are draining the bottom line, or do you feel the most financial pain when you send in your monthly mortgage or rent payment? In other words: Are you eating your retirement? Are you living in it?
Have you ever added up the amount that you spend on food, alcohol, and coffee each month? This is the hardest number for people to crunch because it can hold the most waste. Still, it is the very addition that I have people start with when doing a spending analysis. I recommend printing out the last three months of spending (bank statements, credit card statements, etc.) and averaging out the individual categories until you get one month’s worth of spending. Using three months’ worth of data allows you to account for oddities in your spending, such as anniversaries, vacations, or other abnormalities. This task is daunting, mostly because it forces you to confront the fear that you spend too much money. You hesitate because you “know” that you spend too much, and quite frankly, you don’t want to have to cut back. It’s the same reason we don’t count calories regularly.
When you reach that monthly number that you spend on food, alcohol, and coffee, divide that number by your gross monthly income, which is your pre-tax salary (or annual income) divided by 12. What is that number? Is it higher or lower than you expected? How do you feel about that number?
The next step is to add up all of your monthly housing costs. If you own a home, add together your mortgage, taxes, escrow, and HOA fees. If you rent, use your monthly rent figure. Divide the monthly housing number by your gross monthly income. What is that number?
In my experience, I have found that if your housing costs are less than 22 percent of your gross income, you have a high likelihood of being able to save, travel, and enjoy a little discretionary income. If you are carrying any type of debt — such as credit card balances or student loans — the housing number should be less than 18 percent in order for you to still be able to save and spend a little. If you’re above 22 percent, then there is a good chance that this overhead is causing you a great deal of anxiety, and a move to downsize would allow you to save more for retirement and relieve some of that stress.
Compare your food expense percentage to your housing expense percentage. How close are those numbers? In other words, how does the amount that you spend to feed yourself compare with the cost of your house? If your mortgage or rent is very reasonable (i.e., less than 18 percent of your gross monthly income), then perhaps it’s OK if your food and housing numbers are close. If you are feeling financial strain, though, and you are eating the equivalent of a mortgage payment, it may be time to make a lifestyle change.
You can calculate your expense percentage with any spending category that concerns you. When you have a good grasp of the breakdown of your expenses, you will have a better answer to the all-important question, “Is this how I want to be spending my money?” If the answer is no, you can make lifestyle changes to move toward more intentional spending that reflects where you want your money to be invested.
Advisory services offered through Investment Advisors, a division of ProEquities Inc., A Registered Investment Advisor. Securities offered through ProEquities, Inc., a Registered Broker-Dealer, Member FINRA & SIPC. Stable Waters Financial is independent of ProEquities, Inc.
Katie Waters is a member of the DailyWorth Connect Program. Read more about the program here.