Happy Fiday or FI .. day? however, you want to say it it is all good with me. So welcome to episode 2, and in this episode, we are going to learn about understanding your personal annual costs ? this really is the foundation of becoming financially independent, so wait right there?
Welcome back ? so this episode will be accompanied by a YouTube video to walk you through the examples, but don’t worry I record the podcasts separately from YouTube to ensure the concepts I am running through on the Podcast are suitable for just listening and your not like, oh yeah nice one Dale, great I can’t see what you are talking about ? and now I am even more lost than I was before!
So I have a confession, to make ? I absolutely love spreadsheets, and if you want to get a real quick understanding of the lay of the land I really suggest you learn to love them too ? geeky I know ? but believe me there is something beautiful in making the numbers balance. Just before my wife and I bought our first house together, I carried out a full audit of what was going out every month and one-off expenses during a typical year. To make this process easier, you can split into high-level categories, such as?
Firstly your home ? in this category include all the costs associated with living wherever you lay your hat? That could be?
Rent or a Mortgage
Repairs & Maintenance
Power / Phone / Internet
As well as shelter we also need water and food to live right, so there needs to be a section for this but only include the food and drink you need to survive plus your grooming essentials and women’s bits and pieces I really don’t understand| Anyway? So | for most of us we would classify this as our weekly shop ? long term we can set a budget for this as it really shouldn’t vary by much, week to week.
Next is your personal insurance section ? so life insurance, income insurance and medical insurance. Now, insurance is a whole big topic in itself ? but whilst you have debt and dependent kids this is something not to be scrimped on, as this is the only way you can plan for things that are outside of your control.
So what about transport, if you are not continuously putting one foot in front of the other, this needs to be a category as well.
We need to get to work, to earn the money that pays the bills so how do you get there – if you roll out of bed because you work from home and live close to all the amenities you need ? you may not even need a car ? which can save you sooooooooo much money.
In our case, I have a car and fortunately it, it’s fuel and other associated costs are fully funded by my employer ? so no costs there, but my wife does have a car, so we need to allow for that, and in that calculation, we include lines for:
Repairs & Maintenance
Note that you could allow for depreciation here ? as this could be a separate savings allocation for your next car. For my purposes, I understand this, but happy for it to come out of our overall savings when needed.
Ok for the next category, so some of us also have kids right, well guess what these cost money, but that said we have already sheltered them, fed and watered them and made provisions for them if we aren’t around any more, so that leaves, schooling costs and extracurricular activities ? so look over your past couple of years banks statements and add everything up that was spent associated with schooling and extracurricular and, voila there is your kid’s budget.
The final necessity is clothing, so work out how much you are spending on clothing for your whole family and add this to your spreadsheet.
So through defining these categories of Housing, Weekly Shop, Personal Insurance, Transport, Kids and Clothing, we have covered all our basic human family needs, these are what is purely needed to survive. For those of us that studied business at school you were probably introduced to Maslow’s Hierarchy of needs ? this isn’t just a practical model from a business perspective to help us understand what motivates people but we can also use it to help us assess what is the true cost of our living at different levels of function. Basically, the premise of the model is that the lower physiological and safety needs need to be met before people can be motivated to go on to achieve higher levels needs of love and belonging, self-esteem and finally fulfilling one’s potential or as Maslow put it ? Self Actualisation ? very fancy.
So the categories we have first defined meet all the physiological and safety needs for our families, so our first action is to assess whether our spending in each of these categories are justified in meeting these needs or whether some of this spending is actually excessive, i.e. non-essential ? and once we start to identify this non-essential spending we can start to trim our living costs (in inverted commas).
Now some of these are easier than others and trimming some categories of spend have more impact than others. For example, in the case of my family, the vast majority of our spending goes on the household. This is driven by a big mortgage repayment ? now once you have bought a house it is not always that easy just to sell up, and move to a cheaper area ? we have things to consider like the quality of education for our kids, proximity to friends and family etc. However, such a big-ticket item will have a huge impact on reducing costs and the time taken to get to financial independence |, so it does need to be carefully considered. So for our family, the plan was always to pay the mortgage down as soon as possible. By detailing our costs and recognising from day 1 of buying our house what our likely savings would be in 5 years time, with a purposeful target we will have exceeded our savings target, and in 2020 our mortgage repayments will have reduced from $3,933 to around $1,900 ? also helped by a lower interest rate but the biggest difference will be a one time payment of $230-240,000 off the mortgage in November 2019.
Please remember that the key to maximising your savings is reducing all unnecessary cost, so go through all the categories we have mentioned so far and firstly eliminate all items of spend that are not essential and don’t make you or your family any happier. For questionable items, ask yourself, is there a cheaper alternative? Another big area of impact for reducing spend is on your weekly shop, just look at your latest receipt and go through it line by line and ask yourself, is this essential, is this healthy, is there a cheaper alternative. Here is a Jones Family tip, we use online shopping, yes we pay a delivery charge but has we purchase 6 months of delivery in advance, the cost per week is only around $5-6, and we save time in getting to the supermarket, going around the supermarket, packing the car, driving home and unpacking the car. In addition to this time saving, we can also make sure our shopping is within budget before we pay through the online checkout and the previous order is saved so can easily be adjusted for what we have used the previous week, without the real-world distractions employed by supermarkets with strategic product placements as we shop through their physical aisles.
Ok so I get the idea, and if this was a talkback radio show I am sure the phones would now be ringing off the hook with people complaining about, stuff like but this is all well and good if you only want to a live a dull and boring life and simply survive ? and you would be right we want to climb Maslow’s hierarchy of needs so we need to add one additional category for Leisure and Hobbies. In this section we should include dining out, takeaways, holidays (including weekend trips as well as annual holidays) and any hobbies that really fulfil us and makes us and our families happy. Now, there is a logical reason why we choose this category last, as once we have really determined what the cost of our physiological and safety needs are we can compare against all the after-tax income that comes into the household and the difference between the two can be split into three different pots, these are, as I just mentioned Leisure and Hobbies, then we must add an overall contingency for unexpected spending in any category and finally what is left over should be in the third part which will be the lifeforce towards our FI goal and that pot contains our savings.
So, go ahead and carry out a strict audit on your current Leisure and Hobbies spend, it is being spent as most effective as it could be. Think about every dollar, could you spend less and get the same amount of value and fulfilment from this category ? if the answer is yes, do it and create a new lower budget. Do you then have enough left over for a reasonable contingency and savings? If not, can you sacrifice some spending in the short to medium term for the long term goal of financial independence ? it is at this stage you need to ask the question if you really want to but remember there is a future self you have not met yet and your actions now affect the lifestyle and happiness of that future self- but ultimately the decision is yours. Obviously, if the contingency and savings pot is not large enough at this stage, you could re-look again at the big-ticket items like moving house, or you could look into how you can get extra income ? now again income is a separate topic in itself, and we will cover this is a future episode but for now let’s focus on getting your cost budgeting right for you.
So we can really geeks out with our spreadsheets and create pie charts to really visualise where we are spending each dollar, please do this as it is really insightful and you can see mine on the happy fiday YouTube channel. In doing so, this also gives you a visual target to aim for and by coming back to your spreadsheet at regular intervals your can track your progress and make adjustments to costs and your approach to income as necessary.
So what were the targets for my family over the last 5 years?
Well, I set a spreadsheet out that tackled the following?
on 3rd December 2014, we were going to start with a mortgage of $656,000 after putting $164,000 of our savings down as a deposit (this was the vast majority of our savings, so our savings pot at this point was almost dry. After going through the spreadsheet cost-cutting and budgeting process, I realised we would save on average $40,000 per year for the next five years (not allowing for any increase in income). As I mentioned earlier, we should end up with $230,240,000 of savings; this was achieved through adjusting costs and approach to income as and when required to compensate for unforeseen events, e.g. a couple of years ago we got a new dog. Without the backing of the spreadsheet, we wouldn’t have known what sacrifices and attempts to earn more income would be needed to stay on track.
Finally, the spreadsheet has one more long term use, by simply deleting the mortgage repayment ? you get to see your FI expense figure, this figure adjusted for inflation will be around your total expenses ? this may seem surprisingly low ? and remember you haven’t reduced your leisure and hobbies category at this point and with enough invested you should have enough return where you can really choose what you do with your time whether that returns and income or not ? it is up to you. So there is some food for thought, so until next time? Happy Fiday?