Think of how much you earn, whether it be from a salary, IRA distributions, or another source. Have a number? Great. Now, think of how much you spend.
It’s a lot harder, isn’t it? Most people can easily tell you their earnings but draw a blank on their total expenditures. This can be problematic when it comes to financial planning, as spending is, in a lot of ways, much more important than earning. Spending at a sustainable level, meaning having enough to cover your expenses, make your 401(k) or IRA contributions, and attend to other long-term needs is vital to your overall financial health.
We could probably all agree that knowing your spending is important, but why is it so hard to do? One reason is that we like to avoid pain, and thinking about spending can be painful in the short term. Even though we know it’s necessary over the long run, it can be hard to push through what can be an awfully powerful aversion!
There’s another reason for the difficulty in tracking expenses. To get to the root of it, let’s try another exercise: How much do you spend on your mortgage? Easy, wasn’t it? It’s easier because we have a natural tendency to divide our spending into what behavioral economists call “mental accounts”. In other words, we naturally split expenses into smaller categories, such as the mortgage or our insurance, many of which, like earnings, are fairly predictable. The result is that it’s much easier to estimate each category then the total across categories.
When it comes to tracking your spending, you should take advantage of this natural tendency to categorize. Take a few moments to think about what you spend money on and jot down the amounts. The list probably includes categories like housing, household bills, insurance, entertainment, etc. I’ve attached an Excel budgeting spreadsheet to this article, which might help you in the process. You may also find that your categories look very different! That’s perfectly okay: part of making expense tracking work is to use categories that are easy to remember and which feel natural to you.
Now, some categories might be difficult to compute, and the amounts in others might include a bit of wishful thinking. Thus, I also recommend that you take the time to track your actual expenses. There are as many ways to do this as there are people. Some prefer to look back through their banking and credit card statements once a week or so, while others prefer to keep a running list of their expenses on a Smartphone or piece of paper. Whatever your strategy, I encourage you to try this out, as you might be shocked to find out what you’re spending your money on!
Once you’ve gotten all this information down, it’s time to take a good hard look at the big picture. Are you spending more than you’re earning? Are you able to contribute to savings? Are there any categories that seem out of whack? When you’re asking these questions, think about your larger and long-term goals in addition to the everyday. If your passion is travel, you may want to cut down on some expenses so you can fund trips to exotic places. If you’re very busy and want to pay for a part time personal assistant, you may need to cut down in another area. The point is that there is a balance to be struck between the immediate pleasures of, say, that daily latte and the longer term satisfaction of exciting adventures or more time with your kids.
After you’ve made some decisions, it might take time to readjust to a new spending pattern. I find that putting bill payments and savings contributions on automatic pilot can be incredibly useful. Not only do automated payments and savings deductions free up your mental energy for managing your discretionary spending, but it can help make it easier to achieve your goals. For example, if a set amount of money is being saved for travel every month without your doing anything, you’ll be more likely to stick to the plan!
Of course, it can be difficult to adjust to keeping track of your spending and setting harder limits, but keep in mind that the results, whether travel, more free time, or a more secure future, are immeasurable. I often relate this process to quitting smoking: Like smoking, avoiding thinking about your finances in the short term may be more pleasurable, but it is setting you up for problems 20 years down the road. By quitting (or, in this case, planning ahead), you can help protect the health of the person you’ll become in 20, 30, 40 years. In other words, you need to think about that person, rather than the person looking at you in the mirror today. But taking control over your expenses and planning ahead will not only help you to secure a healthier future: it can set you up for more fulfillment and happiness along the way by helping you to lead the life you really want to live. And isn’t that what it’s all about?
If you are seeking detailed information about rolling over your 401(k) or about managing your IRA, I highly suggest downloading my free eBook, “10 Tips You Need to Know About Your IRA Rollover”. This short book is packed with critical information that will help you make the right decisions about your retirement savings.
Written by Bradford Pine
Bradford Pine Wealth Group – New York City Financial Advisors
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