At the start of every year going back almost 15 years now, I’ve laid out a projected expense budget for the Max Your Freedom household. I attribute much of my financial success over the years to this particular habit.
2017 was no different, with an estimated budget set at $51,000 for the year.
In addition to an expense (spend) target, I also lay out a cash flow target for the year. This cash flow is the engine that drives my savings, which in turn enables me to invest as needed.
But before I compare my actual spend level in 2017 to my estimated target, I’m going to recap the reasons why I think budgeting is a habit every household should adopt.
5 Reasons why you need a Budget
If you’re still working on financial independence and have made that goal your priority, you’ll be hard pressed to achieve that goal without budgeting.
Here are some reasons why this is such an important step…
#1 You are what you measure
It’s a very simple concept but it works like magic. Once you start tracking or measuring something whether it’s your weight, income, debt level, or expenses, it begins to magically improve. Most of the time we’re oblivious to how our money is spent, it comes in one door slowly, and out the other fast.
The first question I normally ask someone living paycheck to paycheck is whether they track their expenses in detail. It always amazes me when the answer is no, which is more often than not. And this applies to both low and high income households.
Maybe it’s the engineer or business person in me, but I couldn’t imagine operating a household without understanding my overhead costs.
#2 Plan for the worst and hope for the best
A budget helps you come up with a plan for your money. If you don’t have a plan for your money it tends to spontaneously evaporate. With a solid budget for the year, you can figure out how much money should be left over (or not).
That helps you figure out how to cover shortfalls if you have any, and if you’re lucky what to do with any excess. It’s also really comforting to have a money roadmap for the year. That’s the best way to build up your financial confidence.
#3 It increases your odds of becoming financially successful
I have yet to meet someone who became financially successful without some form of budgeting, unless of course they started their life making high sums of money or with some type of windfall.
There’s no downside to having a budget. Although it may seem tedious and boring to pull together, it will never hurt you. Having one will only increase the chances of you taking control of your financial destiny.
#4 It leaves you with nowhere to hide
Once you start tracking your expenses and developing a budget, all the inconvenient truths about your spending habits are laid bare for you to see. That’s the scary part. The encouraging part, is that you can now look under that hood, and figure out what to fix.
My budget forces me to make decisions on what I should be prioritizing. In the early years, it forced me to tackle my debt head on. In the later years, it’s helped me optimize my spending so I can bank the savings in hopes of buying more freedom years.
#5 It reduces the odds of lifestyle inflation
Lifestyle inflation is when you increase your spending, usually as your income increases. It’s the primary reason why many high income earners (such as lawyers, doctors, celebrities, etc…) end up living paycheck to paycheck, and with little savings despite their success.
Having a budget and analyzing it every year will quickly highlight if you’re on the path to lifestyle inflation. This doesn’t mean you can’t live a fulfilling and enjoyable life as you make more money. A budget simply gives you the right perspective on setting priorities during your journey.
MYF Household 2017 Expense Budget
When I set my budget at the beginning of this year, I split it into 2 major categories: Operating Expenses, and Travel Expenses.
Operating Expenses were projected to be approximately $3,000/Month or $36,000/Year in 2017
Travel Expenses were projected to be approximately $1,250/Month or $15,000/Year in 2017
My Total 2017 Budget was Estimated at $51,000 for the year.
If you’d like, you can check out the detailed breakdown of the above expenses in the post I wrote earlier this year on setting a budget for 2017.
Going forward I’ll be breaking up my expenses using a slightly different approach, across two primary categories:
Fixed Expenses – These are the expenses necessary to operate my household in a typical year. They represent the bare minimum needed to maintain a basic lifestyle.
I’m not saying that these expenses are all an absolute necessity. We can of course trim back on any number of items. They’re simply the expenses we are comfortable having at this stage of our life. They will change as we go through different phases in the future.
Discretionary Expenses – These are expenses we’re willing to take on to “upgrade” our lifestyle. They include travel, dining out and general fun. If the need arises, they can easily be eliminated from our household expenses.
They can also be used to substitute for an unforeseen emergency or other expense during the year. It’s basically our flex money that’s currently mostly allocated to our desire to travel.
I like this approach because it gives me a clear picture of how much money I will need to generate in early retirement to maintain a certain lifestyle.
It also breaks up core expenses from optional ones.
MYF Household 2017 Actual Expenses
With all the above in mind we can now start analyzing my actual 2017 expenses.
My Total Spend in 2017 was $49,477 which is inline with my Gold Package Lifestyle.
Fixed Expenses were $29,603 or roughly 60% of my total spend, while Discretionary Expenses came in at $19,874 or roughly 40%.
To help visualize where all our spending went this year, I’ve pulled together this handy Sankey diagram courtesy of SankeyMATIC.
As you can tell, we came in $1,523 under budget for the year.
Here are some notable highlights with more detail:
Property Taxes – Our property taxes were 10% higher this year, something I had not accounted for, and tried to dispute unsuccessfully.
Utilities – Our utilities came in about 6.5% lower this year, largely due to our absence during the Summer months.
Transportation – This category will drop drastically going forward since my lease came to an end in December, and since I purchased an awesome used car instead. I plan on rolling over those “savings” into the discretionary expense bucket in 2018 and beyond.
Travel – This was by far our largest single expense category of the year. The summer we spent in Spain/Italy/France was an extremely memorable experience. If you follow this blog, you know that we freed up the money to accomplish that goal by eliminating our mortgage payment.
In case you’re wondering, it took me only 2 hours to calculate our total spend for 2017. I keep a simple spreadsheet I’ve maintained for the past 15 years, and I now have it down to a science. So pulling this information together and keeping track of everything is not a burden.
There were no real big surprises during the year with respect to our operating expenses since we had planned out our spending. As a result we were also able to achieve our savings goal for the year.
Overall I’m pretty satisfied with how we ended the year. We came in right at budget and kept our expenses below the $50,000 cap I recently put in place to maintain our Gold Package Lifestyle. There was no lifestyle inflation whatsoever, even though our net income went up almost 10% this year.
At this expense level we’re able to live what we consider a luxurious lifestyle for a family of three. This is due to the fact we’ve eliminated all our debt, and have about 40% of our expense budget allocated to having fun (discretionary expenses).
If we optimize our Fixed Expenses further, any savings will just flow into our Discretionary Expense bucket. This is what we’ll do with the extra funds from the eliminated car lease monthly payment going forward.
As long as the overall spending stays at $50,000 we’re meeting all our goals. I’m not looking to bank any additional savings off the $50K. At this level of spending we have a very healthy 75% net savings rate.
This will ensure we meet our net worth target by the time I’m ready to FIRE in 5 years.
PS: If you liked that Sankey diagram, you should check out the blogger Sankey chain on Rockstar Finance for other creative versions.
Readers, do you keep a budget? How was your spending in 2017 compared to what you expected? Does any of our spending surprise you? Do you agree that keeping a budget is important for financial independence? Share your thoughts and comments below! – Max