#3 – Know where your money goes
One of the biggest problems I run into is that people are spending more money than they make. And – they have no idea where that money goes. If you ask them to guess where it went, they usually under-estimate, often by as much as 50%.
I’ve found that knowing where your money goes is one of the easiest ways of getting your spending under control and one of the most effective tools in getting your financial life under control.
Tracking your expenses is a powerful process that just about everyone ought to be using. It is a great aid for helping people understand and control their cash flow. Once people have started tracking their expenses, I hear them saying things like: “I can’t believe that we really spend $900 a month on groceries. The data must be wrong.” It usually isn’t wrong.
Once you see where your money really is going, it is easier to make changes to your spending habits.
I suggest that clients estimate (and track) expenses in 7-12 major categories. I find that too many categories become confusing.
Examples of they types of categories I suggest using are:
- Taxes (income, FICA, etc)
- Wealth Building (financial index)
- Housing (Including utilities, etc.)
- Auto expenses (gas, Insurance, maintenance)
- Medical (insurance, co-pays, etc.)
- Entertainment / Vacations
- Save for college for kids
- Personal (clothes, hobbies, gifts)
- Philanthropy (sharing your blessings / charity)
- Save for boat (or other big item)
- Include your goals in your expense tracking. Make your goals visible. The tracking categories above addresses the goals of becoming financially independent, saving for college and buying a boat.
- Keep the number of categories manageable (7-12). This makes the tracking part easier also. It also makes it easier for us to analyze at the end of the year.
- Include taxes and wealth building. This keeps them very visible. Taxes are usually huge, so it is good to make this visible. It makes the benefits of investing in an IRA or 401K more obvious.
- Try to use a time period of year – or longer (I find that a year works best)
- You should also have a budget of planned expenses for the same time period. You can compare what you actually did to what you planned. This helps you become more accurate in future planning.
- Make savings important and visible.
- Plan for large expenses (like a boat or vacation or vacation home)
- Do not track every penny – just try to get close.
- The first year will probably be a shock and you actuals will be way off from your budget. That’s OK. Use it to learn.
- Everyone will have different categories because different things are important to them. Some people have huge pet expenses and some never dine out, but have other expensive hobbies.
- Get started NOW. Some type of expense tracking system is absolutely essential to having a successful financial life. There are many expense-tracking systems available, or you can create your own.
- Available tracking systems include:
- Microsoft Money
- Quicken (and Quicken online)
- Mvelopes (online at mvelopes.com – a monthly fee)
- Mint.com (free). Mint.com seems to be getting rave reviews.
Most of these systems can automatically download data from your bank, credit cards, etc.
If you are not already tracking your expenses, I think that you’ll find it to be an enlightening and empowering experience.