Financial Independence is easy – in theory:
Spend less than you earn, invest the difference, repeat. Depending on your rate of saving you will become financially independent sooner or later. In practice there is much more to it, of course.
At this point I don’t want to get into what you can do to increase your savings rate or your earnings. Let’s just start with the very basics.
How much do you spend? Simple question, right? Simple answer? I found that it’s not that simple for most people when they start on their path to financial independence, including myself.
The reason for this is that there are very few people determined to become financially independent when they first start working. They don’t have a plan how much they want to save and invest, and how much they really need to spend on the essentials of life.
Very often, you naturally spend fairly little while at university or training for a job, as maintenance funds and training salaries are limited. You will be fine living in a flat-share, cooking only basic dishes and even scrimping on entertainment expenses – remember those days of pre-drinking before going to the club? Later on, most of us even cherish these times as some of the best years of our lives.
Spending habits often change when you earn your first salary. You suddenly feel that you have a lot more money available, and maybe you want to treat yourself to some things now that you couldn’t afford before. In any case, money is not that tight anymore, and you might slip into not being as conscientious about your spending as long as you don’t spend more than you earn across a given period of time.
Floating in the status quo
And that’s why I say that the answer to the question ‘how much do you spend’ – might not be that easy. There is a status quo of spending for most of us already when we start thinking about becoming financially independent. As long as we are not constantly in debt we might not be aware of exactly how much we are spending on what per month or per year – it just evens out in the end.
But without knowing exactly where your money goes, it will be very difficult to optimize your spending. When I talk about ‘optimizing’ your spending I don’t mean that you necessarily have to bring your spending down as far as possible. Yes, doing that might result in getting to financial independence more quickly.
You’re not doing yourself a favor, though, if you set your expense level so low that this interferes with your quality of life. The level of expenses you set has to be sustainable. You need to think about on how much you can and want to live in the long run, as this provides the basis for calculating your target net worth or target net income streams.
The idea of ‘optimizing’ your spending should be in line with this. There will be categories of expenses that are more important to you than others. You might value travel very highly while someone else is a foodie. If you know your priorities it’s easier to spend on what you get value from – and still stay on top of your total expenses.
So how can you get going? You probably have several types of expenses with a fixed amount each month, e.g. rent or mortgage and utilities (this might vary in different countries). Then there will be varying amounts spent each month on groceries, going out or gifts, for example.
What I did to get a better grip on our spending was to start with putting down the fixed expenses that occur monthly in a spreadsheet. Then I added the fixed expenses we pay annually or quarterly, such as insurance or property taxes, converted to a monthly amount. This was quite a light-bulb moment for me, as we had paid insurances etc. from a pot of general savings that were not set-up strategically, and I had no grasp of how much this really added up to at all.
Another light-bulb popped up only recently in fact, when I realized that savings for the replacement of big electronic goods, our car, and maintenance of our home should be put into dedicated rather than general savings for more transparency. So you can do better than me and get this right from the start.
The varying expenditures might be a bit more difficult. If you have the data available – check your bank and credit card statements – you can take the total amounts for the last year and average them out monthly. Even if you don’t get everything covered, you do get a start.
Keep on tracking
Then make sure to track everything from now on. You can use an old-fashioned journal or dedicated apps for this. Unfortunately services like Mint or Personal Capital don’t work in Germany (yet), and they are less well suited if you still use a lot of cash, i.e. if your expenses can’t be properly tracked electronically.
I just use Excel for this purpose as well. Whenever we buy something, I take the receipt and put the amount in my spreadsheet. This works perfectly for me. Make sure you choose a tool that you are comfortable with, otherwise it will be hard to keep the habit up.
It is very common when you first build up a realistic status of your expenses that you seem to be ending up with more ‘spare’ money when subtracting your compiled expenses from your paycheck than you actually have left at the end of the month from experience. Check that you’ve really included all items that don’t occur on a monthly basis, expenses during vacations, and any other one-offs. If you start tracking all expenses now, your spreadsheet should match your real spending soon.
Got there? Great!
You’ve set your spreadsheet up and it matches your bank account at the end of the month? Great! Now you can look into whether you’re really spending according to your priorities for a good life. Maybe there is even room for increasing your savings rate and getting to financial independence more quickly. But that’s a topic for another post.
Financial Independence Rocks!