All About Expenditure

This post is a continuation of my previous 2 postings:

1. Financial Planning - Simplified to 4 Variables

2. All About Income

The 2nd posting (All About Income) has also been published at CPF's IM$avvy site.

As the title of this posting suggests, I will now try to give my thoughts on expenditure and how it affects your financial plan. In the first posting, I gave a simplified model that I have always used when I think about financial planning. It basically involves just 4 simple variables of income, expenditure, savings and returns on savings/investments.

The amount a person saves is largely dependent on his income and expenditure. While a person with high income and high expenditure might have low savings, a person with low income and low expenditure might actually have higher savings in absolute dollars and cents!

Take for example a person who earns $1000 per month and spends $950 per month. His savings rate is only $50 per month. On the other hand, a person who earns only $500 per month but spends $400 per month saves $100 per month. That is twice the amount of the supposedly "richer" person.

Expenditure - What Works and What Doesn't

I applaud people who are able to stick by their budgets when it comes to spending money. For me, it is close to impossible. I find it difficult to stick to any sort of budget and also find it too time consuming to calculate every single cent or dollar that I spend.

So how do I control my expenditure? The answer is I don't!

Budgeting doesn't work for me. What works for me is first determining how much I want to save. Experts call this the "Pay Yourself First" technique. After determining how much you want to save each month, you simply set aside that money (be it in a savings plan or separate bank account) whenever you receive your salary.

In this manner, whenever your salary arrives, the amount that you want to save is immediately deducted and goes into a saving plan or another savings account. All that is left in your bank account is the money that you have to spend. Hooray!

Isn't that a better way to view expenditure compared to boring budgeting? (Pardon me if you still use the budgeting method).

So by paying yourself first, you literally get to spend all the remaining money. Of course, the onus is on you to set aside the correct amount of savings that you will like to achieve each month. How much you should save depends on a wide variety of factors and it is too simplistic to give a general rule of thumb.

Current Expenditure versus Future Expenditure

I just coined the two terms above to differentiate between one's current versus future expenditure.

Current expenditure is the monthly expenses one needs to survive each month.

Future expenditure is the expected future expenses that one expects to incur.

As you can see, it is actually quite easy to forecast or predict current expenditure but really difficult to predict future expenditure.

For current expenditure, what you can do is simply add up all the money that flows out of your pocket each month. This would include things like food, grocery, loans, bills, etc, etc. Add all this together and it should give you a rough gauge of your current expenditure.

Future expenditure is a little more tricky especially if you are trying to predict expenditure many years down the road. A simple case of future expenditure could be the case of motor insurance. One usually pays motor or car insurance in one lump sum each year. This might vary from year to year (depending on whether you get into accidents and stuff). If you do not cater enough money for this future expenditure, you might be surprised to see a big drop in your bank account whenever the motor insurance is due.

A more complex case of future expenditure would be your monthly expenditure during your retirement years. As some of us are probably still very far from retirement, it might be difficult for us to gauge how much we might really need. Sometimes, unexpected events like illnesses can occur and might increase our future expenditure. On the whole, experts believe that people need roughly 50 to 60 percent of their last drawn salary during their retirement years. Again, that is hard to predict for the younger folks who just started working as we have no idea what our last drawn salary will be when we retire!

Anyway, to make things really simple, what I do is just make sure that my monthly current expenditure remains roughly the same each year. In this way, I am better able to predict my future expenditure and thus determine the savings rate that I hope to achieve. Savings and expenditure are actually closely linked. If you are not saving much, it is most probably because you are spending too much.

If you can't remember a word that you have just read, just remember this simple message:

Pay Yourself First and Spend the REST!