Chapter 3
Managing Where Your Money Goes
In This Chapter
Understanding why people overspend
Assessing your spending
Tracking your expenses via “free” websites
As a financial counselor, I’ve worked with people who have small incomes, people who have six-figure and even seven-figure incomes, and everyone in between. At every income level, people fall into one of the following three categories:
People who spend more than they earn (accumulating debt)
People who spend all that they earn (saving nothing)
People who save 2, 5, 10, or even 20 percent (or more!)
I’ve seen $40,000 earners who save 20 percent of their income ($8,000), $80,000 earners who save just 5 percent ($4,000), and people earning well into six figures annually who save nothing or accumulate debt.
Suppose that you currently earn $50,000 per year and spend all of it. You may wonder, “How can I save money?” Good question! Rather than knock yourself out at a second job, you may want to try living below your income — in other words, spending less than you earn. Consider that for every discontented person earning and spending $50,000 per year, someone else is out there making do on $45,000.
A great many people live on less than you make. If you spend as they do, you can save and invest the difference. In this chapter, I examine why people overspend and help you look at your own spending habits. When you know where your money goes, you can find ways to spend less and save more (see Chapter 6) so that someday, you, too, can live richly and achieve your life’s goals.
Examining Overspending
If you’re like most people, you must live within your means in order to accomplish your financial goals. Doing so requires spending less than you earn and then investing your savings intelligently (unless you plan on winning the lottery or receiving a large inheritance). To put yourself in a position that allows you to start saving, take a close look at your spending habits.
Many folks earn just enough to make ends meet. And some can’t even do that; they simply spend more than they make. The result of such spending habits is, of course, an accumulation of debt.
Most of the influences in society encourage you to spend. Think about it: More often than not, you’re referred to as a consumer in the media and in the hallowed halls of U.S. government. You’re not referred to as a person, a citizen, or a human being. This section looks at some of the adversaries you’re up against as you attempt to control your spending.
Having access to credit
As you probably already know, spending money is easy. Thanks to innovations like ATMs, credit cards, PayPal, and so on, your money is always available, 24/7.
Sometimes it may seem as though lenders are trying to give away money by making credit so easily available. But this free money is a dangerous illusion. Credit is most perilous when you make consumption purchases you can’t afford in the first place. When it comes to consumer debt (credit cards, auto loans, and the like), lenders aren’t giving away anything except the misfortune of getting in over your head, racking up high interest charges, and delaying your progress toward your financial and personal goals.
Misusing credit cards
The modern-day bank credit card was invented by Bank of America near the end of the baby boom. The credit industry has been booming along with the boomers ever since.
If you pay your bill in full every month, credit cards offer a convenient way to buy things with an interest-free, short-term loan. But if you carry your debt over from month to month at high interest rates, credit cards encourage you to live beyond your means. Credit cards make it easy and tempting to spend money that you don’t have.
You’ll never pay off your credit-card debt if you keep charging on your card and make only the minimum monthly payments. Interest continues to pile up on your outstanding debt. Paying only the minimum monthly payment can lead to your carrying high-interest debt on your card for decades (not just months or years)!
Some credit cards are now trying to sell cardholders “insurance” at a cost of 10 percent annually to pay the minimum payments due on credit-card balances for those months that the debtor is unable to pay because of some life transition event (such as a job layoff). One such card normally charges a 13-percent annual interest rate on credit-card balances, so with the insurance charges, the annual interest rate is 23 percent!
If you have a knack for charging up a storm and spending more than you should with those little pieces of plastic, only one solution exists: Get rid of your credit cards. Put scissors to the plastic. Go cold turkey. You can function without them. (See Chapter 5 for details on how to live without credit cards.)
Taking out car loans
Walking onto a car lot and going home with a new car that you could never afford if you had to pay cash is easy. The dealer gets you thinking in terms of monthly payments that sound small when compared to what that four-wheeler is really gonna cost you. Auto loans are easy for just about anyone to get (except maybe a recently paroled felon).
Suppose you’re tired of driving around in your old clunker. The car is battle-scarred and boring, and you don’t like being seen in it. Plus, the car is likely to need more repairs in the months ahead. So off you go to your friendly local car dealer.
You start looking around at all the shiny, new cars, and then — like the feeling you experience when spotting a water fountain on a scorching hot day — there it is: your new car. It’s sleek and clean, and has air conditioning, a stereo, and power everything. Before you can read the fine print on the sticker page on the side window, the salesperson moseys on up next to you. He gets you talking about how nice the car is, the weather, or anything but the sticker price of that car.
“How,” you begin to think to yourself, “can this guy afford to spend time with me without knowing if I can afford this thing?” After a test drive and more talk about the car, the weather, and your love life (or lack thereof) comes your moment of truth. The salesperson, it seems, doesn’t care about how much money you have. Whether you have lots of money or very little doesn’t matter. The car is only $399 a month!
“That price isn’t bad,” you think. Heck, you were expecting to hear that the car would cost you at least 25 grand. Before you know it, the dealer runs a credit report on you and has you sign a few papers, and minutes later you’re driving home with your new car.
The dealer wants you to think in terms of monthly payments because the cost sounds so cheap: $399 for a car. But, of course, that’s $399 per month for many, many months. You’re gonna be payin’ forever — after all, you just bought a car that cost a huge chunk of your yearly take-home income.
But it gets worse. What does the total sticker price come to when interest charges are added in? (Even if interest charges are low, you may still be buying a car with a sticker price you can’t afford.) And what about the cost of insurance, registration, and maintenance over the seven or so years that you’ll own the car? Now you’re probably up to more than a year’s worth of your income. Ouch! (See Chapter 6 for information on how to spend what you can afford on a car.)
Bending to outside influences and agendas
You go out with some friends to dinner, a sporting event, or a show. Try to remember the last time one of you said, “Let’s go someplace (or do something) less costly. I can’t afford to spend this much.” On the one hand, you don’t want to be a stick in the mud. But on the other hand, some of your friends have more money than you do — and the ones who don’t may be running up debt fast.
Some people just have to see the latest hit movie, wear the latest designer clothes, or get the newest smartphone or tablet device. They don’t want to feel left out or behind the times.
When was the last time you heard someone say that she decided to forego a purchase because she was saving for retirement or a home purchase? It doesn’t happen often, does it? Just dealing with the here-and-now and forgetting your long-term needs and goals is tempting. This mindset leads people to toil away for too many years in jobs they dislike.
Living for today has its virtues: Tomorrow may not come. But odds are good that it will. Will you still feel the same way about today’s spending decisions tomorrow? Or will you feel guilty that you again failed to stick to your goals?
Your spending habits should be driven by your desires and plans, not those of others. If you haven’t set any goals yet, you may not know how much you should be saving. Chapter 4 helps you kick-start the planning and saving process.
Spending to feel good
Life is full of stress, obligations, and demands. “I work hard,” you say, “and darn it, I deserve to indulge!” Especially after your boss took the credit for your last great idea or blamed you for her last major screwup. So you buy something expensive or go to a fancy restaurant. Feel better? You won’t when the bill arrives. And the more you spend, the less you save, and the longer you’ll be stuck working for jerks like your boss!
Just as people can become addicted to alcohol, tobacco, television, and the Internet, some people also become addicted to the high they get from spending. Researchers can identify a number of psychological causes for a spending addiction, with some relating to how your parents handled money and spending. (And you thought you’d identified all the problems you can blame on Mom and Dad!)
If your spending and debt problems are chronic, or even if you’d simply like to be a better consumer and saver, see Chapter 5 for more information.
Analyzing Your Spending
Brushing your teeth, eating a diverse diet including plenty of fruits and vegetables, and exercising regularly are good habits. Spending less than you earn and saving enough to meet your future financial objectives are the financial equivalents of these habits.
Despite relatively high incomes compared with the rest of the world, some Americans have a hard time saving a good percentage of their incomes. Why? Often it’s because they spend too much — sometimes far more than necessary.
The first step to saving more of the income that you work so hard for is to figure out where that income typically gets spent. The spending analysis in the next section helps you determine where your cash is flowing. Do the spending analysis if any of the following apply to you:
You aren’t saving enough money to meet your financial goals. (If you’re not sure whether this is the case, please see Chapter 4.)
You feel as though your spending is out of control, or you don’t really know where all your income goes.
You’re anticipating a significant life change (for example, marriage, leaving your job to start a business, having children, retiring, and so on).
If you’re already a good saver, you may not need to complete the spending analysis. After you save enough to accomplish your goals, I don’t see as much value in continually tracking your spending. You’ve already established the good habit — saving. Tracking exactly where you spend your money month after month is not the good habit. (You may still benefit from perusing my smarter spending recommendations in Chapter 6.)
The immediate goal of a spending analysis is to figure out where you typically spend your money. The long-range goal is to establish a good habit: maintaining a regular, automatic savings routine.
Notice the first four letters in the word analysis. (You may never have noticed what they spell, but I feel the need to bring it to your attention.) Knowing where your money is going each month is useful, and making changes in your spending behavior and cutting out the fat so you can save more money and meet your financial goals is terrific. However, you may make yourself and those around you miserable if you’re anal about documenting precisely where you spend every single dollar and cent.
Saving what you need to achieve your goals is what matters most.
Tracking spending the low-tech way
Analyzing your spending is a little bit like being a detective. Your goal is to reconstruct the crime of spending. You probably have some major clues at your fingertips or somewhere on the desk or computer where you handle your finances.
Unless you keep meticulous records that detail every dollar you spend, you won’t have perfect information. Don’t sweat it! A number of sources can enable you to detail where you’ve been spending your money. To get started, get out/access your
Recent pay stubs
Tax returns
Online banking/bill payment record
Log of checks paid and monthly debit card transactions
Credit and charge card bills
Ideally, you want to assemble the documents needed to track 12 months of spending. But if your spending patterns don’t fluctuate greatly from month to month (or if your dog ate some of the old bills), you can reduce your data gathering to one six-month period, or to every second or third month for the past year. If you take a major vacation or spend a large amount on gifts during certain months of the year, make sure that you include these months in your analysis. Also account for insurance or other financial payments that you may choose not to pay monthly and instead pay quarterly, semiannually, or annually.
Purchases made with cash are the hardest to track because they don’t leave a paper trail. Over the course of a week or perhaps even a month, you could keep a record of everything you buy with cash. Tracking cash can be an enlightening exercise, but it can also be a hassle. If you’re lazy like I sometimes am or you lack the time and patience, try estimating. Think about a typical week or month — how often do you buy things with cash? For example, if you eat lunch out four days a week, paying around $6 per meal, that’s about $100 a month. You may also want to try adding up all the cash withdrawals from your checking account statement and then working backwards to try to remember where you spent the cash.
Separate your expenditures into as many useful and detailed categories as possible. Table 3-1 gives you a suggested format; you can tailor it to fit your needs. Remember, if you lump too much of your spending into broad, meaningless categories like “Other,” you’ll end up right back where you started — wondering where all the money went. (Note: When completing the tax section in Table 3-1, report the total tax you paid for the year as tabulated on your annual income tax return — and take the total Social Security and Medicare taxes paid from your end-of-year pay stub — rather than the tax withheld or paid during the year.)
Tracking your spending on “free” websites and your PC
Software programs and websites can assist you with paying bills and tracking your spending. The main advantage of using software or websites is that you can continually track your spending as long as you keep entering the information. Software packages and websites can even help speed up the check-writing process (after you figure out how to use them, which isn’t always an easy thing to do).
But you don’t need a computer and fancy software to pay your bills and figure out where you’re spending money. Many people I know stop entering data after a few months. If tracking your spending is what you’re after, you need to enter information from the bills you pay by check and the expenses you pay by credit card and cash. Like home exercise equipment and exotic kitchen appliances, such software often ends up in the consumer graveyard.
Plenty of folks have trouble saving money and reducing their spending. Thus, it’s no surprise that in the increasingly crowded universe of free websites, plenty are devoted to supposedly helping you to reduce your spending.
More of these sites keep springing up, but among those you may have heard of and stumbled upon are Geezeo, Mint, and Yodlee. I’ve kicked the tires and checked out these sites, and frankly, I have mixed to negative feelings about them. The biggest problem that I have with these “free” sites is that they’re loaded with advertising and/or have “affiliate” relationships with companies. This simply means that the site gets paid if you click on a link to one of their recommended service providers and buy what they are selling.
This compensation, of course, creates an enormous conflict of interest and thoroughly taints any recommendation made by “free” sites that profit from affiliate referrals. For starters, they have no incentive or reason to recommend companies that won’t pay them an affiliate fee. And, there’s little — if any — screening of companies for quality, service levels, and other criteria important to you as a consumer.
Also, be forewarned that after registering you as a site user, the first thing most of these sites want you to do is connect directly to your financial institutions (banks, brokerages, investment companies) and download your investment account and spending data. If your intuition tells you this may not be a good idea, trust your instincts. Yes, there are security concerns, but those pale in comparison to privacy concerns and apprehension about the endless pitching to you of products and services.
Another problem I have with these websites is the incredibly simplistic calculators that they have. One that purports to help with retirement planning doesn’t allow users to choose a retirement age younger than 62 and has no provisions for part-time work. When it asks about your assets, it makes no distinction between equity in your home and financial assets (stocks, bonds, mutual funds, and so on). Finally, these sites generally offer no phone support, so if you encounter a problem using them, you’re relegated to ping-ponging e-mails in the hope of getting your questions answered.
I noticed over time that many “free” financial websites were singing the praises of the software “You Need A Budget” (YNAB). I test-drove the product (which is like a slimmed-down version of Quicken) and found it to be a decent, but not exceptional, product. My research uncovered the fact that the makers of YNAB pay a whopping 35 percent commission to website affiliates who pitch to users and direct them to buy the product. The owner of a website flogging YNAB pockets about $21 to $24.50 of the software’s sales price ($60 to $70 a whack) for each customer it refers who buys a copy. Does that taint a site’s recommendation of YNAB? Of course it does.
Paper, pencil, and a calculator work just fine for tracking your spending. For those of you who want to try computerizing your bill payments and expense tracking, I recommend the best software packages and discuss websites in detail in Chapter 19.