The first task is to figure out exactly how much after tax income you will have coming in for the year. This tells you how much you have to spend — period — end of discussion — no way around it. You may have had years during your working life where you would be able to spend more in any given year than you took in because you still had a chance to recoup that down the road — but don’t bet on it happening in retirement.
Figuring out your after tax income will likely be the easiest thing you have to do in all of this. I find that most people I talk to know exactly how much money is being deposited into their coffers each month down to the penny, so that is not an unknown. It’s understanding exactly where it all goes that remains an elusive, arcane mystery, for many folks.
Next up is to identify exactly which specific expenses you should be tracking. It is also very helpful to then group the related expenses together in categories (e.g. Residence, Lifestyle, Transportation, etc.). Although many of these expenditures will be somewhat similar for all of us, like our housing costs, each family will have different interests, obligations, or spending choices.
I cannot honestly recall how I came up with the set of expense categories that we still use today. I assume they just evolved organically. However, a few years ago I did start looking for publications and online resources that offered ideas on what households were spending their money on and tracking. Partially, this was to help me make subtle decisions as to what purchase should fall under what category (e.g. should light-bulbs fall under maintenance, or consumption?). So, if you are stuck, look online or consult the many financial planning books you will find in your local library.
If you are interested in how I do it, I will be posting all of the expense items and categories that I use in our tracking in my next article. To flesh this all out a bit, and to get you thinking about what it is you are spending your own money on, I will also be identifying some very specific expenditures that are associated with each.
Fixed, Fixed-Variable, Variable, Intermittent
If you haven’t ever sat down and attempted to identify individual expenses and categories before, it is a good idea to first look at them in terms of what are “must” spends or pays, and then move towards the things that are really just optional purchases — i.e. do you really need to spend money on this stuff?
The four groups I like to use as a frame of reference are Fixed, Fixed-Variable, Variable, and Intermittent. These are my own variations on standard expense labels. Fixed expenses are ones that you pay regularly, you generally don’t have much control over how much you have to pay, and can’t really get out of paying them. Many of these are related to your residence (mortgage, rent, utilities, insurance, etc.) or to large purchases (e.g. car loan, car insurance, etc.).
Fixed-Variable are things that may not be rigid financial commitments like a mortgage, but can be categorized as “must have” necessities. Good examples are food, clothing, hygiene and cleaning products, and gas for the car or transit fares. You have to have them, but their costs may vary considerably based upon how willing you are to shop around or modify usage.
For me Variable expenses are pretty much everything else. Things you like to spend money on, but can probably live without if you had to (e.g. entertainment, booze, recreation activities, etc.).
Intermittent expenses are ones you know will crop up unexpectedly from time to time, but you are hoping they won’t do so for a long time (e.g. new roof or furnace, new car, emergency health cost, etc.). I find that the Intermittent ones are the ones that are most difficult to budget for because they usually pop up out of the blue. This is why it is also important to have a contingency fund — another topic for another day.
Retirement Spending Will Be Different Than Working Life Spending
One of the books I read when preparing for retirement was Warren MacKenzie and Ken Hawkins’ “New Rules of Retirement: What Your Financial Advisor Isn’t Telling You”. They recommend that if you are not yet retired you should begin to track your spending three years before your retirement begins. A very good suggestion, but even if you still have many work years left, you really should start right away. If you are already retired then you need to start — today.
The point to MacKenzie and Hawkins assertion is that you can be generally guaranteed that in retirement your spending and budgeting will be different then it was while you were still working. If you have been tracking your spending all along, that difference should pop out at you. If you haven’t been doing any tracking, perhaps it won’t. In our case, some of our expenses, like gasoline consumption, have dropped off dramatically. Others, like travel, have increased. And, many of the things we used to budget for, like RRSP contributions and savings, no longer appear in our budget at all.
What Tools Should I Be Using?
The manner in which you create your budget and track your expenditures is a personal choice. I use Quicken 2007 for Mac software because I like the built in budget function, how it easily compares my expenditures to my budget, and how easy it is to create and track categories. A good friend, who has the exact same computer technology available to him as I have, still does this work with pencil and paper in a ledger.
If you are using your computer and don’t want to spend the money on specialized software it can be done in a spreadsheet. Don’t want to pay for Excel?– then download the completely free Open Office (https://www.openoffice.org). It is a great open source productivity suite that many corporations have switched to. You can even save your documents as Excel documents if you want to share them. Here is a link to a possibly useful tracking spreadsheet offered up by the Credit Counselling Society (http://www.nomoredebts.org/learning_credit/monthly-expense-tracker.html). It too will provide you with some ideas as to what you should be tracking.
The Government of Canada provides a number of resources through the Financial Consumer Agency of Canada website, including information on Making a budget and sticking to it. They also provide access to a downloadable Excel Budget Calculator spreadsheet.
For those of you who are interested, I will be looking at a number of different types of tracking software, like Quicken, in a future article. There are many, many available at a variety of price points, including free.
It doesn’t really matter how you do it. What matters is that you do it!
Strike the Budget
Once you have it clear in your mind what it is you are spending your money on it is time to strike your budget. It is as simple as determining how much you think you will spend on each of your expenses for the year. Estimating monthly amounts for each is how I do it. You will find that after doing this for a couple of years you will become very accurate at predicting your spending patterns. The most important rule in budgeting — once again — don’t budget to spend more than your income for the year!
*Updated April 7, 2016 – to include information about resources available through the Financial Consumer Agency of Canada website.
