If you are like most people, you’ve never sat down and thought about how much you spend. Most likely you never needed to. You had a steady job with money coming in weekly or bi-weekly.
Only after you know what you are spending, can you determine if your budget is in balance. Fingers crossed it is! Otherwise, you’ll likely be accumulating debt.
I am here to offer guidance on how to determine how much you are spending. Because understanding what you are spending, is the first step in understanding and creating a budget for yourself.
Three methods to identify your spending are as follows:
- Create a budget
- Use your paycheck
- Use your tax return
Method 1 – Create A Budget
Hands down this is the most accurate option. Track what you are spending each month for several months. You’ll start to notice a pattern.
Sounds easy right! Unfortunately, it’s not. Creating a budget is one of the most difficult things I ask my clients to do. It’s amazing; few have ever gone through the process of tracking what and where they spend their hard earned money. They get trapped in the never ending cycle of making money and paying bills, never taking the time to step back and see what’s happening.
You might be familiar with the term “living paycheck to paycheck.” By creating a budget, you can get away from this situation and get a better handle on your finances.
When creating a budget, you should look at two types of spending:
- Fixed Expenses – Expenses you pay the same amount for every month (mortgage, rent, car)
- Variable Expenses – Expenses that you pay every month, but vary in value (gas, groceries, entertainment, that costly morning coffee, latte, chai tea at Starbucks )
Fixed expenses are easy. They are expenses you pay every month, and you know the cost. You are prepared to pay for them and know what to expect. For example a fixed expense budget might look like this.
- Mortgage – $2,500
- Car Payments – $700
- Utilities – $350
- Other Insurance(s) – $500
- Total Fixed – $4,050
Variable expenses prove to be more challenging. Instead of itemizing every coffee and knickknack you buy, I suggest you group your variable expenses into buckets. The goal here is to obtain a realistic estimate of your monthly variable expenses, not drill down into the details. It may look like this:
- Gas – 6 fill-ups a month at $60/each – $360
- Groceries – 1 shop per week at $150/each – $600
- Meals/Entertainment – eating out and other activities – $600
- Fun money – The monthly slush fund (used to supplement the rest) – $800
- Total Variable Expenses – $2,360
Is this a perfect science? No. But taking these steps will get you moving in the right direction.
In this example, the total expense need for this household would be $6,410 per month (variable expenses plus fixed expense) or $76,920 per year.
Method 2 – Use Your Paycheck
Using your paycheck is a reasonably straightforward technique to determine how much you are spending each month or year.
Let’s assume you receive the same paycheck each pay period. Take that number and multiply it by two (for example, assuming a $3,500 paycheck per period, the math would be $3,500 x 2 = $7,000).
Now I ask you this question: At the end of each month, do you feel as though you can’t wait for the next pay period? Or do you feel as though you have cash to cover your expenses?
Assuming the answer is “yes, there is some room.” I can reasonably assume $84,000 per year ($7,000 per month x 12 month) is enough.
(Now for those of you saying I get paid 26 times a year, I hear you. Those two magical months when your company pays you THREE times!! But using 24 paychecks a year makes the math easy. Try it for yourself. Try living off two paychecks per month. If it works, you’ve just found a way to save two whole paychecks per year… put them towards the beach house!)
Method 3 – Use your Tax Return
I love taking clients through the process of analyzing their gross wage (what your company tells you they pay you), down to your net wage (what you actually get to spend). I love this primarily because I am a geek and numbers are fun to me, but secondarily because it’s eye-opening for my clients.
It is easy to talk in gross wages; what your company tells you they pay you. But what matters to you is your take home pay after taxes and other deductions. For anyone who has ever analyzed a pay stub, you see how substantially different the numbers are.
Here is our example: a married couple with two kids and a gross wage of $150,000.
- $150,000 – Gross Wage
- $15,000 – 10% contribution into the employer sponsored 401(k) plan
- $2,175 – Medicare tax (1.45%)
- $7,250 – Social Security tax (6.2%)
- $15,000 – Federal income tax (estimate)
- $4,605 – PA state income tax (3.07%)
- $1,500 – Local earned income tax (1.0%)
- $10,000 – Assuming shared medical cost
- $94,470 – Net Wages
How quickly $150,000 goes to $94,470. In this scenario there is no tax refund as the end of the year, so this family’s annual spending would be calculated at just under $95,000.
So What Now?
You can see here three different ways to look at spending (keep in mind these were not intended to be the same answer. I randomly created three separate scenarios to show you the process).
But to be honest, it’s rare that I take clients through this process and the 3 produce the same answer. More times than not, we are able to identify “extra” income.
Once you can identify extra income, you can develop a savings strategy and put this money to work.