Managing Expenses

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​For many people, a budget may invoke the idea of a diet. Budgeting doesn’t always mean cutting something out rather it is a guide to alternatives that honor your financial plan.

​Why the focus on managing expenses?
We spend most of our earning years saving for retirement so that we will be able to afford our desired lifestyle in retirement.  Whatever we save along with social security and other forms of income like pensions and annuities are finite.  However

• If left unchecked we have an infinite capacity to spend  
• A limited capacity to generate income when we “retire” from our career, and
• An unknown lifespan 

So most of us (unless you’re Elon Musk or Jeff Bezos) have a finite amount of income and some of us (it seems) have an infinite ability to spend.   Keeping track of spending by formalizing a budget and savings plan can ensure that we do not spend beyond our income and our need to save for retirement.  This is what sets us up for success to achieve our goals for retirement.

Managing expenses:  A Lifetime Endeavor
In the financial scheme of things there are just a few things that we can control and many more that we cannot.
We can control:

• Spending (including borrowing)
• Saving
• How we invest

We cannot control:

• Taxes
• Healthcare costs
• Inflation
• Interest Rates
• Market Performance
• Long tail events (Pandemic)
• Household Shocks (sudden illness,  job loss, tornado, etc)
• Longevity (how long we will live)

Hence, it is critical to focus on the first three factors which, in turn, affords us the best chance of successfully navigating through the eight factors which we cannot control.  Should you doubt the veracity of this methodology, I suggest you read The Millionaire Next Door.  Published in 1996, it still remains a best seller in 2021.  Thomas Stanley and William Danko researched over 11,000 wealthy families, and one of the most common characteristics of these millionaires is that they lived within their means and kept an annual budget.  When facing the choice between status and savings, they chose savings.  They also saved and invested for the long term.
 
Stanley found that income explained only about 30% of the variation in wealth. The overwhelming impact of the other 70% was due to lifestyle.

Likewise, in Morgan Housel’s The Psychology of Money,  Housel provides another way to think about expenses and saving.  He writes “Wealth is just the accumulated leftovers after you spend what you take in.  And since you can build wealth without a high income, but have no chance of building wealth without a high savings rate, it’s clear which one matters more.”  That simple statement sums it up.

Why is Managing Our Expenses So Difficult?
Why is losing weight difficult?  One of the reasons is we have psychological blindspots when it comes to money, according to the Wall Street Journal. 

• We don’t give future expenses enough thought.  In general, as people grow wealthier, their expenses grow as well.  
• Home equity lines of credit are used more when home values are going up.  
• We often use credit even if we have savings and can end up paying very high interest rates to pay off a purchase rather than pay cash because we do not want to deplete our savings.  
• We spend (or eat) more when we are unhappy.  Happier people save more.  

Women face additional systemic difficulties.   Often women are at a financial disadvantage compared to men because of the gender pay gap. It is also not uncommon for women to experience one or more career interruptions in order to provide family care. Gaps in wages will then directly impact how much women can save.  Additionally, if women are earning less, then they are accumulating fewer social security benefits.

Managing Expenses Aligns Activities with Goals
We all have different goals, both in life and in retirement.  Managing expenses for all of us is an effective tool within our control that helps us achieve whatever goals we desire.  An important part of thoughtful financial planning is knowing your expenses to determine what goals are feasible, as well as what choices/tradeoffs can be made.

How do I Calculate My Lifestyle Expenses in Retirement?
Start with a spreadsheet or sign on to Mint (free).  Mosaic Fi also provides an expense tracker through our portal for our clients.  Gather up your information starting with

• Credit card statements
• Bank statements
• Loan statements
• Pay stub

Enter your information, creating your own expense categories along the way.  Generally, having 6 months worth of data provides a good look into expenses.  You can sum by month, average, then multiply by 12 for annual expenses, then divide by 12 to determine monthly expenses.  Don’t forget the “sneaky” expenses like automobile purchases, 1x home repair or renovation, semi-annual or annual insurance, property taxes, and/or healthcare and dental expenses.

Once you have calculated your current annual expenses you can

• Use 100% of current expenses or
• Use a percentage of that number, i.e.80%, or
• Review each line item and increase/decrease the category based on your desires and assumptions
• Add new categories and delete others

Don’t get overwhelmed with the details.  Coming up with a ‘ballpark’ figure or getting very specific, (if you are a more detail oriented person), will both move you in the right direction.

Benefits of Managing Expenses
Managing expenses helps us control the things we can to give us the greatest chance of success in reaching our goals.  Perhaps even more importantly, it provides peace of mind, financial independence, and the freedom of choices.

There are no magic formulas for expense to savings ratios, however, there are a variety of formulas that can be good guideposts. 
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For example:  One of the most frequently asked questions by pre-retirees is “how much do I need to save for retirement?”  According to FIRE (Financial Independence, Retire Early) it is at least 25X a household’s annual expenses if one plans to use a withdrawal rate of 4% in retirement. So, if your annual expenses are $150,000/yr, 25X is $3,750,000.