Financial grip in 90 minutes
In 2010 I started my first job as a PhD student. My net salary was around €1600. However, I was able to buy a house and it felt as if I could do whatever the heck I pleased.
In 2016 my wife was pregnant with our first child. My net salary had doubled and my wife was also earning a salary. Yet at this point we felt that there were months that were longer than our salaries. How was that possible? The two of us had lived off an income that was less than half or our current salaries. And we felt a lot of freedom. Now we were at a point where we felt completely opposite. That’s when I realized that financial freedom is about 75% mindset and 25% income. Lifestyle inflation really is a thing.
From that moment on I’ve been tracking our finances on a weekly basis. In this article I’ll share the lessons that I learned from that, and how I created our mindset of financial freedom again.
Insight is key: Understand your expenses
The very first thing that I did was track all the expenses on my account. I did this for about two months to see where our money went. I also categorized each of the expenses as I tracked them. This showed me there are basically two types of expenses (1) fixed and (2) variable. It’s not rocket science. Any textbook on household finances will teach you that. Yet, putting this into practice made the difference for me. Actually tracking where money goes might surprise you. That €2,50 for a coffee doesn’t sound like much. But if you do that every working day of the month you may find yourself €50 lighter.
The benefit of fixed expenses is that you can easily calculate with them and they are plannable. They will always happen at the same time for (approximately) the same amount. Typical examples of fixed expenses are your mortgage or rent, insurance fees and housing expenses such as electricity and heating.
Herein also lies the difficulty with variable expenses: they are not plannable. You never know when they are going to occur and what the amount is. That means that it is extremely difficult to get a grip on those expenses. After all, are you keeping track whether this is your 10th coffee this month? Not me. Typical examples of variable expenses are groceries, gifts or presents, clothing, and snacks, drinks, dinners, etc.
After marking everything as a fixed or variable expense I started to categorize my expenses. This has taken me several months of refinement to come to a categorization that works for me. If you plan to do this, you can take this list as a reference:
- Housing: Everything that you need to play to live in your house. Example: mortgage, local taxes, electricity and heating, water supply
- Insurances: Everything that you have covered with an insurance. Examples: health, travel, car, house, belongings
- Groceries and household: Everything that you consume with your lifestyle. Examples: food, drinks, personal health articles, cleaning articles, etc.
- Travel & commute: Everything that you spent regularly on getting from A to B. Examples: Car depreciation, maintenance, fuel, parking, train and bus tickets, taxi, Uber, ride shares, etc.
- Holiday & leisure: What you spent on holidays and fun stuff you do. Examples: flights, events, festivals, thema parks, bars, restaurant, hotel, activities
- Subscriptions and entertainment: Any subscription you have on services and products. Examples: newspapers, journal, gym, sports club, streaming services such as Spotify, Netflix, Disney+, but also Dropbox, Google One, Amazon Prime, etc
- Appliances & electronics: These expenses don’t occur often, but they have a big impact. A new television, XBox, refrigerator or washing machine takes a large chunk out of your savings. The same applies to getting that new smartphone every one or two years.
- Childcare: Of course this only applies when you have children. But let me tell you a fact: they cost money. Lots of it. Examples are: diapers, clothing, daycare, etc.
- Saving: Money you want to put aside for a later moment or for unforeseen circumstances. Example: well…your savings account.
Exercise: Try this at home! Log in to your online banking environment. Export and download the expenses on your account for the last three months. Open the file in a spreadsheet editor. For each of the expenses mark whether it is a fixed or variabele expense. Then assign it to a category. This will probably take you about about 30 minutes (depending on the number of expenses) to cover the last two months.
Planning is control: Everything can be fixed
The key insight came to me when I understood that even my variable expenses were more or less the same over the different months. That is when I realized the trick to getting back in control is that I had to convert all my expenses to fixed expenses. This is comparable to the idea of ‘budgeting’. However, budgeting normally has the goal to reduce or limit your costs and to stay within budget. That is not the intention that I had. I simply wanted to get a grip on my expenses again. I could always decide to reduce my spending by budgetting certain expenses.
The trick to get back in control is to see everything as a fixed expense
In this second step I went through all my variable expenses and calculate the total that I had spent in the period I was looking at. I then averaged to a week. For example: I would pay about €130 on fuel for my car in a month. But one week it would be €0, the other week €55 and then €40. By looking at a larger period of time I calculated that on average I would need €40 per week on fuel.
Some key learnings that I’ve had by doing this for several years:
- More data results in a more accurate estimation. The longer period you look at, the better your estimation will be. If you have data of your expenses for a year it is much easier to calculate a reasonable number.
- Round numbers, and round them up so you get easy numbers to calculate with. It also feels much better to have money left than having to chip in again later.
- You don’t need to calculate every thing. Just calculate things that don’t have a frequently occuring pattern. For me that means things I have to pay anyway such as clothing, hairdresser or fuel.
With these calculations you probably have some numbers on what you spent on average for these categories. This is essential information for the next step.
Look back at what you’ve done now: you’ve been able to turn around an unpredictable spending pattern into a controllable and predictable savings scheme. Big round applause for yourself! (Don’t worry if it is not 100% accurate yet. It will be over time).
Exercise: Continue with the sheet you’ve created in the previous exercise. Look at all your variable expenses. Calculate what you’ve spent on those for a longer period of time (minimum 2 months, but longer is better). Average what you spent per week. This should also take you about 30 minutes to calculate for each of the categories.
If you’ve not done so in the first exercise: calculate what you need to save up for the highly infrequent spendings such as a new washing machine, or new mobile phone.
Clear your head: Automate your finances
My ultimate goal was to achieve financial flexibility. I didn’t want to worry about reaching the end of the month. That means that I want to have sufficient money available to live the way that I want. (Quick note: this is not a method that will give you more money, so you can’t change your lifestyle. This is only a method to get grip on your existing lifestyle and maintain it). In order to clear my head I decided to fully automate my finances. That meant that I would always have sufficient money available to live comfortably, and never have to worry and calculate how much money I should still keep on my bank account to pay the bills for the rest of the month. Instead, I would know exactly how much I still have left up to the next paycheck.
The steps that I took:
- Create a savings account for each of the categories that weren’t paid regularly. For me this means General savings, Electronics & appliances, Car depreciation & maintenance, Holiday, Clothing & personal care, House maintenance, Interior & decoration, Subscriptions, Healthcare, Birthdays and presents. (Depending on your bank you may need to set up lots of saving accounts. My bank offers different “buckets” under a savings account, which allows me to do this).
- Set up an automated deposit to put money into each of these accounts on a regular interval. I have two intervals: monthly (always the first of the month) and weekly (every monday). The amount you put into the account is of course what you’ve calculated in the previous exercise.
As an example: on the first of the month I have 25 automated deposits triggering to these different buckets. Additionally I have two weekly deposits triggering.
Some tips:
- You might want to put a first “saving period” into each account to have a safety margin.
- The more certain you are about your exact spending, the lower you can set the frequency of deposits. You might want to start off with weekly deposits to make sure that you have a steady flow of money coming in.
Exercise: Log in to you online banking environment. Set up the different savings accounts or buckets. Set up your automated deposits. Since you have the numbers available from the previous exercise, this should not take more than 30 minutes as well. (Depending on how long it takes to get savings accounts activated you may need to do this another day).
Whenever you have to buy something, you simply withdraw the money from the correct account.
Congratulations! You have now fully automated your finances and are back in control!
I have this system going for several years now. Here are some reflections on how it changed my behavior:
- In general I feel confident about my financial state. I know that I will make it to the end of the month, and that I have sufficient money to cover for any expected expenses.
- I used to search for the ‘cheapest, yet acceptable’ product when I bought something. Now, I search for a product that fits my spending range that I really like. For example: It would normally take ages for me to decide on a washing machine, as I want to weigh all options to make sure I made the best choice to fit my budget. Once I decided I would find another one that would be slightly cheaper, with slightly less features, but that would leave me with more money left for other unknown expenses. Now that I know I have sufficient money for those expenses, I can make choices easier.
- I tend to overestimate how much money I need for each category, which leaves me with some extra savings at the end of the year. After all: if you overestimate each of your automated deposits with €1, and you have 25 deposits, you save up an additional €25 each month!
- I know with a single glance on my bank account how much money I have left for this month. Decision making has never been easier.
Overall, I’ve been able to get myself into a mindset where I’m comfortable spending money on the things that I value. I do not have the feeling that I need to save up more for unknown situations. If you’ve done this, I’m curious to haer your experiences.
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Remco Magielse is a product manager at CM.com. CM.com is a high tech company focusing on Conversational Commerce in The Netherlands. He has worked as a system engineer and product manager at Philips Hue. Remco has gained his Ph.D. on the dissertation titled ‘How to design for adaptive lighting environments: Embracing complexity in design’. He writes articles about product and software development, and the hard- and soft-skill required for product management. He is passionate about innovation and has contributed to approximately 50 patents.
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