Since January of last year, I have tried to track, on Quickbooks, every expense I have had.
This is an interesting experiment and something I would highly recommend to anyone to do - perhaps on a regular basis, for several reasons:
1. You can figure out "where all the money is going" and take steps to cut back on expenses.
2. You can figure out what you will actually need to live on, once you retire.
3. You can see the benefits of various cost-cutting measures over time.
After a year, the data is rather interesting. Of all the expense items the following are the largest 12 categories, with the last being "other" of 3%:
- Taxes - 36.53%
- Interest Expense 21.04%
- Insurance 8.56%
- Automobile Expense 8.35%
- Food and Beverage 7.74%
- Maintenance & Repairs 6.66%
- Travel & Entertainment 2.89%
- Utilities 2.70%
- Medical 1.96%
- Pets 0.64%
- Other 3.04%
I do not submit that this breakdown is TYPICAL of anyone else's lifestyle, other than the first two items.
Taxes, including Federal, State, Social Security, Medicare, property, etc. take a lion's share of one's income. There is little one can do to reduce this burden, other than to take every legitimate deduction you are entitled to and to legitimately structure your finances to minimize your tax burden. But for most people, this is largely an unavoidable, fixed expense. We will minimize our property tax burden down the road by selling our vacation home prior to retirement. After "doing the math" we realized that we can rent a vacation home for nearly a month in the summer, for the price of the annual taxes on our existing vacation home.
Interest Expense is rather large as it reflects mortgage interest payments, which constitute the bulk of most folk's mortgage payments. Until you are about 10 years into a mortgage, the payments you make don't really put much of a dent into the principal of the loan. So interest expense is the bulk of it.
This year, we had some credit card interest payments, due to my business, and also because I had a last-minute Capital Gains tax bill to pay. But I have since paid down some of that debt and rolled over the rest to low interest or no interest credit cards. Next year should see a small reduction in this slice of the pie.
Insurance was one area where I have cut expenses ruthlessly. I was very over-insured, having many life policies, excessive coverage on home policies, and too much coverage on car policies. I have trimmed this expense more than half, by converting some life policies to paid-up status (so they require no future payments) and also dropped excess coverage and raised deductibles for car and homeowners coverage.
Automobile Expense here includes storage fees for my boat ($3000 a year) so that is also rather high. I plan on selling this boat in the spring, so the storage fees should drop to zero next year and cut auto expenses by at least a third.
Gasoline represents another third of this expense. With one less boat to feed (at 1.5 mpg) and also less lawn to mow (See my post, The Great American Lawn) we will probably cut gas expenses as well. I also have been experimenting with gas mileage on my existing cars, which have gas mileage meters built-in. You can increase gas mileage by nearly 50% merely by changing the way you drive. One of my convertibles averages 28 mpg with reasonable driving. But you can bring that down to under 20 quite easily, by changing your driving style.
Food and Beverage is another expense that is impossible to avoid, but easy to trim. We have already cut this in half over previous years, I estimate (I do not have data from previous years to compare, unfortunately). We have taken to shopping at Wal-Mart or Tops, as opposed to Wegmans, and carefully tried to utilize the wholesale club (while avoiding the temptation to over-consume). I am not sure much can be done to cut this further, other than to consume less. I could stand to lose some weight. But frankly, food is one area where you do not want to sacrifice quality for price.
Liquor, including beer and wine, makes up a sizable portion of this slice of the pie. We have been more aggressive in shopping prices on liquor. We no longer buy as much New York State wines (at $20 a bottle, often no bargain) and instead take advantage of the worldwide wine glut - many excellent bottles of wine can be had for not a lot of money, if you shop around. Of course, cutting back on drinking or eliminating it entirely would save even more money.
Maintenance & Repairs includes trips to Home Depot for projects around the house. This year, we finished off a basement room, which should add value to our home. But I have been avoiding the temptation to "shop" at Lowes or Home Depot and buy things we don't really need. Many consumers come home from there with armloads of tchotchke stuff to decorate their gardens with. Most of it is plastic or painted metal from China, and it rusts and falls apart before credit card bill is paid. Our big expense next year for maintenance will probably be a new boiler for our vacation home, so this may actually go up.
Travel & Entertainment: Since we travel by RV a lot at the present time, much of this expense is covered under automotive. I am hoping that down the road, we can travel more and see more of the world. We do not eat out at restaurants a lot, so this portion is relatively small. Most Americans spend an alarming amount of money on restaurant food, and it shows.
Utilities: This would be larger, but a portion of them can be written off to my business. We are fortunate to have two homes that are inexpensive to heat and cool - they are both well insulated and have modern heating and cooling systems.
Medical: is also low because we are pretty much in good health. This does NOT include our health insurance (under "insurance") but does include doctor's co-pays, one MRI scan, and dentist visits. Again, we have a high ($10,000) deductible health insurance policy. Some of these expenses might have been covered by a lower deductible policy, but our premiums for the insurance would be much, much more than the amount paid here in cash. I think we came out ahead.
Pets: Veterinary bills are the culprit here. Our dog had some medical issues last year. Nothing major, but veterinarians charge a lot of money, compared to doctors. We love our dog, but my advice to someone living on a budget is to think long and hard before getting a pet - if you are struggling to make ends meet, can you really afford to spend hundreds of dollars a year on pet food, shots, and a vet? See my blog, the Pet Trap.
This exercise validates my previous post about Disposable Income and Cost Cutting. Note that more than half my expenses are for taxes and mortgage interest. As a result, the amount of "disposable" income is a mere fraction of overall income.
Thus, cutting even small amounts of unnecessary expenses, or getting better deals on things can make a huge difference in your usable disposable income. In other words, saving $10 here and there does matter, and it does add up over time.
Never let someone convince you than squandering small amounts of money "doesn't matter".
How Do You Track Expenses?
It is not easy, to be sure. And we have not 100% tracked every expense, either, but are getting better at it.
First, you have to monitor your bank and credit card accounts regularly - almost daily in fact. We have computers and websites now, and this takes a few minutes a day to log on, enter data into Quickbooks, and reconcile your accounts. As an added bonus, it means that any attempted fraud on your account will be more readily spotted. And of course, if you check your finances this way, you will never bounce a check or go over your credit card limit.
We have tried to use the debit card more (running it as credit for transactions) despite the fear-mongering tactics of the Credit Card industry. Thus, as each transaction appears on the bank website, I can enter it in Quickbooks and categorize it. Quickbooks automatically categorizes transactions based on the last transaction. So once you enter a transaction from Exxon as "Automobile Expense, Gasoline" the next entry for Exxon will be categorized as such, unless you change it.
Cash was a problem we approached from two directions. First, I save all receipts and enter them into a "Petty Cash" account on Quickbooks (Quicken might work for you and is usually provided free with new computers). Second, we take out less cash than before, to force us to use the debit card more (which has the side effect of discouraging spending).
By the time we approach retirement, we should have a good handle on nearly every penny spent. At that point, we will understand better what our financial needs are and how much money we can comfortably spend for the remainder of our years.
You'd be surprised how many people never do this exercise. In the past, one could excuse them, as with nothing more than a checkbook register, it would be hard to figure out where the money goes. But today, with computers, you have no excuse not to track your expenses more closely.
UPDATE: I am still using Quickbooks Pro 2000 in 2020 - twenty years later! It is still available for sale on Amazon, too. But any accounting software will do, including shareware or whatever, so long as you log each purchase you make - that is the key. Fancy pie charts and crap are far less helpful and meaningless without proper independent logging of your spending and income.