At the most basic level, you have to understand what your life costs. Since I am a HENRY and I am writing to an audience of HENRYs, I assume you have at least some basic understanding of what your life costs monetarily. You likely know how much you make and what you spend, at least on some level. You may not necessarily concern yourself with all the details, but you probably know where you fall on the spectrum below:
- You spend more than you make (i.e. you are going into debt)
- You spend everything you make (i.e. you are not going into debt but not saving anything)
- You spend less than you make (i.e. you have a positive savings rate)
Understanding where you fall, is the first step. However, that is just the tip of the iceberg. As a high earner who is not rich yet, you are undoubtedly spending a significant amount of money. Otherwise, you would already be rich, or well on your way to being rich. The key is understanding the details. For that reason, today I want to focus on the importance of understanding where you spend your money, how that aligns with your values, and the opportunity costs in your life. Today, I want to focus on what your life truly costs.
Understanding Where You Spend Your Money
To understand what your life costs, you must first understand where you spend your money. Understanding where you spend your money boils down to one thing. You have to track every dollar you spend. You have to understand and acknowledge where you spend ALL of your money. This isn’t just your monthly budget to include all of your recurring expenses. I am talking about every dollar you spend to include non-recurring expenses, small (and sometimes large) impulse purchases, pleasure spending, etc. All of it.
To understand where you spend your money, let’s first bucket spending into three broad categories:
- Essential Spending – This includes all the necessities of life. Housing, transportation, food, utilities, insurance, healthcare, etc. Although these expenses are essential, the range of spending in each can be very broad.
- Non-Essential Spending – This includes personal spending, travel, entertainment and miscellaneous spending. This can be thought of as lifestyle spending. This category is very personal and once again the range of spending in each area can be very broad.
- Saving/Giving – This includes all forms of saving to include retirement accounts, taxable accounts, emergency funds, etc. I would also include giving in this category.
As you can imagine, there are a lot of nuances in the essential and non-essential spending categories. These are also the categories often funded by consumer debt including mortgages, car loans, revolving debt (credit cards), etc. When I first discovered financial independence, I would have argued I had a good grasp on my essential spending. I had a budget and knew my expenses. However, I really was not paying too much attention to the details within my essential spending, and I definitely was not paying close attention to my non-essential spending. In order to understand where I spent my money, I had to first acknowledge that I did not know where every dollar went. I then had to track my spending. So… I did. I analyzed every dollar I spent in a year. I then proceeded to track every dollar I spent for one additional year. It changed my life.
How to Track Your Spending
There are several methods for determining where you spend your money. All require that you either track your spending or analyze your spending after the fact (in retrospect). Let’s look at a couple of options for tracking your spending below.
Option 1: The Old Fashioned Way
Some people love to put a pen or pencil to paper. Some people, including myself, love spreadsheets. If you are somebody that likes to do it yourself and wants to go through the exercise of not only tracking your expenses but recording each one individually, then this is the way to go. Again, this is more than a budget. This is tracking every dollar you spend so you can understand your essential and non-essential spending as well as your recurring and non-recurring expenses. If you choose this option, be prepared to track your expenses for an extended period of time so that you can get a true understanding of where you spend every dollar. This option will take time but the same outcome can still be achieved.
Option 2: Spending Reports
Most people today do the majority of their spending on credit or debit cards. As a result, you can leverage the spending reports provided by your bank or credit card provider. You also can utilize the pre-existing spending reports that some institutions provide. This method allows you to pull reports for an extended time period so you can truly see your spending over a prolonged period. For this reason, this is one of the easiest ways to analyze and subsequently understand your spending.
Option 3: 3rd Party Software
The easiest, fastest, and most effective way to track your expenses is to use software specifically designed to do so. There are many options currently in the market. A couple of popular options in the FIRE community include Quicken, Personal Capital, Mint and YNAB (You Need a Budget). There are various pricing structures to each of these options, and they all have various pros and cons. I personally used Option 2 above to analyze my historic spending and then used YNAB to track my expenses point forward. YNAB consistently rates best overall for budgeting. The software is very user friendly, allows you to link to your various accounts if you prefer and it comes with a free trial period. I will eventually do a full review of the software to include tutorials and how I use the software to track and reduce expenses. For today, my goal is to present you with options. There are many cost effective software options that will pay for themselves many times over if you use them to their fullest extent. YNAB is only one of them.
My Recommendation
As I noted above, most people do the majority of their spending on credit or debit cards. For this reason, I recommend a hybrid approach. I recommend you aggregate and analyze your spending reports for an extended time period (1 year is ideal, but 6 months will work) to gain a true understanding of where you spend your money. From there, I recommend a 3rd party software like YNAB to track your spending going forward.
Understanding The Opportunity Cost of Your Life
I had a good understanding of where I spent my money. However, once I analyzed my spending over a year, I was shocked. Not only was I spending far more money in essential spending than I thought, I was spending significantly more on non-essential spending. I did not have a good grasp of where I was spending money outside of recurring expenses. I came to realize I was spending money everywhere and it wasn’t adding additional value or happiness to my life. If it was, in many instances, the happiness was quickly replaced by the desire for something new, something better…
Once I began to understand where I spent my money, I next needed to understand the opportunity costs in order to truly understand what my life costs. Opportunity costs are essentially trade-offs. Every time you make a choice, there is a trade-off. In addition to gaining something, you are giving up something. You are making a choice. Many people only focus on what they are gaining and not what they are giving up.
Now apply this idea to your life. How often do you think about the opportunity cost associated with your time? How often do you think about the opportunity cost of your money and where you spend it? Understanding both of these are at the heart of the FIRE movement and the pursuit of financial independence.
Only once you understand where you spend your money, can you begin to understand what your life really costs. Using what you learned from tracking your spending, ask yourself this question:
Does what I am spending my money on bring value and happiness to my life?
Many people, including myself prior to discovering financial independence, think their spending aligns with their values and what brings them happiness. However, once you discover the possibilities financial independence presents, these questions take on a different meaning. You begin to ask yourself these questions through a different lens. Every dollar you spend equates to additional time you have to work. That country club membership, luxury car, frequent dining out or love of travel in fact does have an opportunity cost. The opportunity cost is your time. The opportunity cost is your life.
The more money you spend, the more time you spend working to make more money to spend. The more money you spend on things that you do not value or that do not bring you additional happiness, the more time you spend working to make more money to spend on things that you do not value or that do not bring you additional happiness.
Sure, I love being a member of a country club, driving luxury cars, eating out, and traveling. I love having a new iPhone every year or two years, the latest television or the latest must-have consumer good. However, I began to see my spending in a different light. A question began to weigh heavily on me. Were all of these things truly bringing additional value and happiness to my life? Were they really worth 10, 20 or 30 years of my life? The answer was clear.
The True Cost of Your Life
The truth is most people do not understand or choose to acknowledge what they are giving up to maintain their HENRY lifestyle. They do not understand or consider the opportunity costs. I did not, but I do now. Let me now ask you the question above in a slightly different manner.
Are you willing to work an extra 10, 20, or 30 years to pay for the things you spend your money on? Do those things bring true value and happiness to your life?
Once I began to look at my spending differently, I was changed. I began to gain a better appreciation for what my life costs outside of just my expenses. I began to see the opportunity costs. I was sacrificing my time for things I did not value or that did not bring me measurable happiness. Once I discovered this, I was never the same again. I finally understood what my life truly costs. If you take the steps above, I am confident you too will start to see the opportunity costs of your life. In doing so, you too will discover what your life truly costs. You too will be changed.
Regards,
Henry