Understanding your spending is the first step when planning your retirement. Whether you track on paper, a spreadsheet, an app or an automated online tool; it is essential to have a complete picture of your money habits. I have read that four out of five Americans keep a budget, but 20% of those that have a budget keep the numbers in their head. For retirement planning purposes, a mental spending plan is not sufficient.

I make a distinction between monitoring your spending and budgeting:

  • Monitoring your spending is a baseline personal finance skill that involves observing how much you spend and then breaking the spending into categories (e.g., Oh, I spent $47 on alcohol this month).
  • Budgeting = Monitoring your spending + determining specific spending allowances in each category (e.g., I’m only going to spend $25 for alcohol this month and no more).

Unless you are inherently frugal, building a budget should be the goal. Get started with monitoring and move to budgeting as quickly as possible.

It is impossible to plan a successful retirement without understanding your spending. Additionally, the tracking must be captured in writing.

One of the most common measurements used in the early retirement community is the 4% Rule. This rule states that for every $12,000 of annual spending you intend to have in retirement you need $300,000 saved and strategically invested. Another take on this rule is to multiply your annual spending by 25 to calculate the amount of money you will need to have saved for retirement. So, your annual spending (or your planned annual spending in retirement) needs to be known to make this calculation. Understand what you spend now to have a projection of what you may spend in retirement.

The 4% Rule.
Multiply annual spending by 25 to calculate savings you’ll need to retire

Lowering your annual spending reduces the amount of money you need to have saved for your freedom. Reducing your spending and/or accelerating your savings are the metrics to focus upon to bring your retirement closer. By monitoring your spending, you will be able to evaluate and possibly reduce your spending in various ways. Odds are when you start tracking and can calculate the number above it might seem like an unattainable target. By adjusting your spending today and your planned spending in retirement, you will be on the path to hit your target. It may require a lot of change, but you can get there.

Without a solid understanding of where your money is going, your secured freedom will remain in the distant future. Noticing what you spend also brings into focus areas for improvement. If you spend thousands of dollars per month on clothing, it will show up in your budget. If making these purchases is worth working for many more days/weeks/months/years, feel free to keep spending in this category. Tracking allows you to calculate the impact of your spending choices. If you make $200K per year and spend $190K per year, it is unlikely that you will be retiring any time soon. Ultimately, your expenditures are more important to financial independence than how much you earn.

Where does all the money go?

By substantially changing our spending habits, Amy and I accelerated our retirement by many years.

Start a practice of tracking (and eventually budgeting) so you will be able to:

  • Understand your spending
    • Start with tracking and move to budgeting
  • Tactically reduce your spending
    • Be brutally honest with yourself about what you need to live a good life
  • Determine your required annual spend to calculate your savings goal
    • Deflate your lifestyle to improve your life – there is fat in almost every budget
  • Take the money you cut from your budget and reallocate it to savings
    • Is that $50,000 SUV worth 2 years of your freedom?

In my next post I will write about some of the tools (often free) that are available for automating your tracking.
Do you currently keep a budget? What tools do you use? Please comment below.