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This post continues my FI Basics series for those new to financial independence. If you haven’t had a chance yet, you can check out the two most recent posts, Dealing with Debt, and Two Numbers to Track Immediately.
Today, we’ll focus on the financial independence lever that you control most directly: spending.
Spending is powerful because it impacts both how much you can save/invest AND how much you need to reach financial independence. Spending $100 less a month means you have $1200 a year more to invest AND you have to save $30,000 less in order to reach financial independence.
Nothing else (short of a windfall) has the same ability to accelerate your path to FI. Fortunately, spending is entirely in your control.
Three Steps to Sorting Your Spending
There are three different actions to sort your spending and build your path to FI.
- Know Your Spending
- Control Your Spending
- Reduce Your Spending
Action 1: Know Your Spending
We are all familiar with the Peter Drucker quote “What gets measured, gets managed.”
Simply paying attention to something helps you understand it better and increases the likelihood that you’ll make positive changes. For example, several studies have found that keeping a food journal consistently leads to greater weight loss. Timing yourself during exercise pushes you to improve your time.
Similarly, tracking your spending may be the single most impactful thing you can do to build financial independence. I believe everyone seeking financial independence should track their spending for a period of time. Try it for at least three months. (This was one of our 2018 goals.) It will give you a greater understanding of your spending habits. Then, you can decide if tracking works for you long-term.
Three common ways to track spending:
- Mint.com: Takes a bit of effort to link your accounts, but then it’s very simple. This is what we chose to use for our first three months.
- Quicken: A little more complexity and control. Quicken users swear by it as a tool.
- Your Own Spreadsheet: I know several financial independence bloggers that track every expense in a spreadsheet. The argument is that this gives you the highest level of awareness and control.
The two things I say most frequently apply here: Choose what works for you and just get started.
Action 2: Control Your Spending
To control your spending – avoid increasing it. This sounds simple, but most people increase their spending throughout their working lives. As income goes up, so does spending. Of course, we all know people that increase their spending even without new money.
Lifestyle inflation is a trap. The world works against us by providing constant cues to spend, spend, spend. It is not easy to resist. But, it is easier to control your spending than it is to reduce it after increasing lifestyle cost.
To control your spending, avoid adding new expenses whenever possible. Do you need a new car, or is your current car good for a few more years? Does that subscription make your life better or just more expensive?
If you get a raise at work, apply the vast majority of it to savings or debt paydown. Some people use a 50/50 rule here and apply 50% to investments and 50% to lifestyle. I prefer to shoot for a 90/10. 100% to investments would be even better!
You can take these simple actions now and dramatically increase your chances of reaching financial independence.
Action 3: Reduce Your Spending
If you want to accelerate your journey to FI, then you won’t stop at simply controlling your spending growth. As I mentioned earlier, every dollar you can cut from your spending is worth double on the journey to financial independence.
This is where Action 1: Know your Spending comes in handy. If you have been tracking your spending closely, you’ve likely discovered a few things. I, for example, discovered a ridiculous amount of money I’d been spending on lunch out. A simple adjustment to take my lunch to work saved almost $100/month.
Recurring expenses are a particularly powerful area to target. Any savings you can get from a recurring expense leads to massive savings over time since it accumulates each month. Perhaps you can drop a tier on your cable plan and save $10 a month? That’s $120 a year! Even better, maybe you can cut cable entirely. (We saved $60 a month by cutting the cord.)
It’s likely that you’ll find at least some expenses that you can reduce without significantly changing your lifestyle. However, many on the path to FI search for deeper savings. Some live a “frugal life” while others engage in “extreme frugality” and seek to live on very small annual amounts.
I focus on reducing unnecessary spending, but the frugal life is not my area of expertise. If you are interested in exploring more, a simple google search will take you to many great resources.
A Big Question: To Budget or Not?
Budgets, much like diets for weight loss, are a hotly debated topic. While I believe that tracking your spending is critical, I believe budgeting is a personal choice.
Some believe budgets are unnecessary and restrictive. In this view, simply monitoring your spending is enough. Interestingly, in a recent post, ESIMoney found that relatively few millionaires used a budget on their way to accumulating wealth. Of course, is that causation or simply correlation with a more privileged group who has more room in their financial life?
Others advocate that a budget is critical to control your spending. If you believe it would be helpful to have a budget, here are budget templates from Budgets Are Sexy. (You can tell how they feel about this question.)
Here is a post from FrugalRules about budgeting by percentages.
Personally, we approach budgets by doing an annual review and setting a budget for the year. We then use this to identify a savings goal for each month. This gives us a framework and lets us identify when we have significant variance. If we hit our savings goal, we know we’ve hit our budget. If not, we dig in. This simpler approach works better for us than adhering to a strict budget.
Whether you use a budget, or not, it is important to take these three actions to speed your FI journey.
- Know Your Spending: Track your spending to identify savings and needs
- Control your spending: – Avoid lifestyle creep!
- Reduce your spending: Every reduction accelerates your FI journey.
In the next post, we’ll use your spending information as a key component for Setting Your Financial Independence Number.
Update: Here is the index of the entire FI Basics Series if you’d like to hop around other posts in the series:
- Financial Independence Primer
- Dealing with Debt
- Sort Your Spending to Speed Your Journey (You are Here)
- Two Powerful Numbers to Track
- Setting Your FI Targets – How will you know when you are financially independent?
- Strategic Savings: Create, Secure, Deploy
- Investing: 5 Keys and 2 Examples