This part may be the most emotionally difficult part for some of us.
This is because there is a strong human instinct, to hide from the scary thing.
It is obviously a useful instinct. After all scary things are, well…, scary!
If we live in a jungle, or in a war-zone, this instinct can save our lives.
However, this instinct can also activate in less helpful situations, like when the scary thing is an abstract one.
e.g. a problem in a relationship, a doubt about ourselves, or a worry about our finances.
The instinct drives us to hide, by not looking the problem in the eye;
It hopes that, if we don’t look at the problem, maybe the problem won’t see us and will leave us alone.
However, there is a really powerful magic principle to tap into here.
When we think of a problem, it becomes bigger and stronger.
But, when we look at a problem, it becomes smaller and weaker.
How do we look at a problem? By measuring it!
In this case, what we need to measure is how much money we make and how much we actually spend.
Not how much we should spend, not how much we want to spend or how much we think we can spend if we make some small changes.
How much we actually spend, and what we spend it on. Across all types of expenditure. Cash, bank transfers, credit and debit cards, store credit etc.
The steps themselves are rather straightforward. I’ll run through them here and point out any tricky bits.
Step 1 – Our monthly spending
The first step is to get a history of our spending over the last few months (3 to 6 months is a good start). Including cash, credit cards, bank transfers, the works. Basically all the money flowing out from us.
This includes so called “one-offs”.
One thing this exercise usually highlights is that many one-offs are actually fairly regular. Whether it was a parking ticket you didn’t expect, or a friend borrowing some money because they are in a jam.
It may be a different ticket next time, or a different friend in a different flavor of jam. But you will need to spend the money again, so you need to measure it.
An easy way is to download our bank and card statements, then identify the transactions from there. For items where we paid cash, we need to try to remember what we spent it on. (if there are errors or gaps in the first draft, we will get the chance to correct them as time goes on).
We will then need to group them into categories. We want the categories to be detailed but not so much that they become impossible to manage.
For instance, a “Bills” category needs to be split more. Because each bill represents a different event and function in your life. A phone bill has a very different value level to you from a water bill or a gym membership.
A “Shopping” category also needs to be split. Because shoe shopping is a very different mental exercise (and has a different personal value) from grocery shopping.
However, bread doesn’t need to be in a different category from milk. When we decide to spend money on groceries, we usually think of them more or less as a block.
(If bread takes up a huge chunk of our budget though, it might be worth giving it a separate category.)
In my first draft I had roughly 25 categories. Which was detailed enough for me to process, without being too burdensome.
For each category, we need to add up our total spending for the period and then divide by the number of months to get the average.
Step 2: Include long term expenses
The list is not complete yet though. There are some items that we don’t pay for every single month.
Car insurance may be paid once a year, perhaps the water bill is once every 3 months, even birthday presents for all our friends spread throughout the year.
If we usually spend about £120 on Christmas presents every year. That £120 will not magically appear in our November pay packet. So, to be ready for it, we need to save £10 every month. Then, when December comes around we will be ready.
It will be harder to remember everything you have spent money on over the last year. That’s okay.
For now, we just need to try to remember as many as we can and estimate how much money we spend per year. (When in doubt always pick the larger estimate/ worst case scenario).
Then we divide each yearly total by twelve (to get a monthly value) and add it to the list.
There is a common saying that “January is a long month”. This refers to the fact that waiting for that January payday, after all the expenses from the December holidays, can seem to take forever.
However, if we correctly measure, plan and prepare for the holiday expenses, then January will become as short as every other month.
At this point we are already better off. We have a better understanding of the problem and will automatically begin to make more informed decisions, because we are more aware of the downstream impact.
This list is not a final thing though. We have estimated some things and it is possible we even totally forgot some others.
As we go through the following months and years, we need to take this list with us. Adjusting and correcting as we go along.
For those of us who spend cash, there would have been more estimation in the original list. But, after a couple of months, this adjusting and correcting period will catch most of them.
The final part of measuring – Compare income vs outgoing
In one hand we have this list. We should add up all the different categories to see the real total that we spend each month (including long term and other unexpected expenditure).
Then, in the other hand we have our monthly salary and/or other income.
We need to compare the two.
When we do, there are three possible results.
Result 1 – Our expenses are higher than Our income:
This is a worrying place to be. We are currently in a hole and sinking.
We may already be aware of this, or it may be a hidden pressure building up in secret, that is going to explode in our near future.
That’s okay though, because we now have a clear idea of exactly where that spending that is pulling us downwards is coming from.
The first thing to do is to stop digging.
We need to cut our expenses! Drastically and immediately!
I’m not talking about “Spend a bit less on this” or “Save a bit more on that”. This is showing that our lifestyle is wayyy more than we can afford.
We need to take that list we have made and remove whole categories!
- Cancel our cable tv package and/or our gym membership.
- Scrap or sell the car and move to cheaper accommodation where we can use public transport.
- Stop buying any takeaway food and cook everything we eat.
We need to keep cancelling categories until our expenses are 5 to 10% less than our income.
Not until they are equal, until they are 5% to 10%less.
If they are equal, any small unforeseen issue will push you back into a downward slide. You need to have some wiggle room between the two in order to survive.
You may be thinking at this point, “I thought this was a series about getting more out of your money. But here it is, talking about NOT spending instead.”
That is a valid observation. However, at this stage, it is like coming to learn how to swim while holding unto a bowling ball.
Yes, bowling is fun and swimming is fun. But, if you enter the pool without letting go of the bowling ball, you will drown.
Result 2 – Our expenses and income are roughly equal
If our listed monthly expenses and our income are exactly equal, this is still a bit of a worrying place to be.
For one thing, when creating that list we did a lot of estimations and probably forgot some things. For another, life always has surprises hanging around somewhere.
So, we need to treat that case the same as Result 1. Cut drastically!
If we only have a small amount of wiggle room, maybe around the 5% mark, then we can begin doing smaller cuts and adjustments. Like shopping at a cheaper grocery store or fine-tuning our mobile phone bill.
Our aim is, at least, to get to the 10% mark.
Result 3 – Our income is higher than our expenses (10% or more)
This is where things can start to get interesting.
At this point we are already in a much better situation than before.
However, simply being in this position doesn’t guarantee anything! I was at this position for many years and still had no savings. I even still had increasing debt!
This is why I make a big deal about that extra 10%. It is not a luxury. It is necessary just to keep afloat.
The real advantage we have at this point is that we are more aware of our situation. We can see the impact of decisions and changes ahead of time. We can prepare, we can plan.
There are people who simply take this method of ruthlessly measuring the problem, then add a whole lot of self discipline, and get incredibly spectacular results.
They are able to manage their money, pay off their debts and build an impressive amount of savings and investments.
However, self discipline is a separate skill. It takes time to learn, practice and become good at.
(It is an incredibly useful skill though, and we will discuss ways to learn about it and build it in future articles).
However, for our purposes, we are not relying only on all our different personal levels of self discipline.
What will we use instead? Magic of course! 🙂
The full “Getting More Value from Your Money” series
For Further Study
Mr Money Mustache – Getting from Zero to Hero
Mr. Money Mustache writes about how living a more frugal life can actually increase our happiness, while allowing us to save enough money to retire in our 30s!
Even if our own life goals may be different, he has tons of great advice on how we can reduce our spending while improving our quality of life.