I am not a financial advisor - this is just to document how I do things.
I developed this system when I was contemplating retirement and needed to get a good handle on my expenses. I wish I had done this decades ago, but it wasn’t even possible before electronic banking.
Short version:
1. Know what predictable, recurring, expenses you are committed to monthly
2. Have a separate bank account to pay them
3. Have payments made automatically
4. Use a service to track all this in one place
1. Itemizing predictable expenses
When I started thinking about retiring, I needed to know what my expenses really were – what did it cost me to “keep the lights on” or “keep the ship afloat.” The trouble was, I had never separated my ongoing, predictable expenses from my others, like entertainment or travel. And I had never categorized even my predictable expenses into necessary or voluntary.
So step 1 was to set up a spreadsheet (any spreadsheet will do) and start listing everything I could find that was recurring. This ranged from big items like mortgage, insurance, and taxes, to little things like subscriptions to web sites that were only a few dollars per month.
I went through my credit card statements and bank statements. I checked PayPal. Every time I saw a payment that recurred, I put it in the spreadsheet.
The spreadsheet listed the payments, plus – and this is vital – a column that prorated the payments into a monthly amount. Some were already monthly, like the cable bill. But my water bill was paid every two months, so I divided the payment by 2 to show the monthly equivalent. Some payments were twice a year; the taxes were annual. In every case I calculated what it cost per month. Coming up with this list required going through an entire year of statements.
Note that when I was doing this I didn’t judge whether these payments were necessary or not. I figured that would just slow me down – that could come later.
After finding all the predictable recurring payments, I added three things that vary but happen every month: gasoline, groceries, and restaurants. To get those amounts I went back a few months and calculated an average.
Now I had a total. I knew that if I had that much money coming in every month I could continue to live exactly as I had been. And I knew what I had left over that I could spend on entertainment or travel or whatever.
Also, I could lower the number a bit if I dropped some of the items, like subscriptions for things I wasn’t actually reading or using. It can be helpful at this point to separate the list into items that are necessary and items that are a choice. Taxes and insurance are necessary. Netflix is not.
2. Separate accounts
In order to make the predictable / voluntary expenses distinction more clear, I set up a new checking account at my bank just for the predictable expenses. And I got a credit card for this. You could also do a Paypal account, or Venmo, or any other means you use to pay bills.
I set the credit card to be paid, in full, automatically every month, from the bank account.
I seeded the bank account with enough money to last a couple of months, based on my calculation from step 1.
3. Automate payments
The next step was to make every payment possible automatic. I went through the list from step 1 and set everything to withdraw money automatically from my bank account. If that wasn’t possible, I set them to be paid with the credit card or Paypal.
(The reason for preferring automatic withdrawal from the bank account is that credit cards expire after a few years and then anything being paid by them needs to be updated.)
The only thing I haven’t been able to automate is my town, village, and school taxes. Each of these happens once a year and they have no arrangement that would allow automatic payments. I have them set up as payees in my bank account so I just have to schedule these when I get the bills in the mail. Typical that government would be behind the times.
I set some of the money I have coming in every month to be direct-deposited into the autopayment back account. Now I can just monitor the balance to make sure that there is enough money there to keep the system going.
[To think that in the old days I would get bills in the mail, then I would write checks and put them in envelopes, put a stamp on them, and mail them back. So much time we don’t have to spend any more!]
4. Tracking service
This is a separate issue from the items above and is worth doing even if you don’t do 1 – 3.
There are a number of services that can connect to multiple accounts and display all their activity in one place. Your bank account may do this. I have used Intuit Mint, Microsoft Money, Tiller, and Quicken Simplifi. Other options are out there.
The advantage of these is that you can go to one place to see what charges have been made to all your credit cards and bank accounts. You can quickly check to make sure that all the charges are legitimate, and take action if anything appears that shouldn’t be there.
One other item that is also separate from the above: set every credit card to pay the minimum balance automatically. Then you never have to worry about forgetting to make a payment and getting penalized.
Conclusion
Having done all this . . .
- I know exactly how much money I need to continue my current lifestyle
- I can see, every day and in one place, any charges that have been made to any of my credit cards or bank accounts, to make sure they are legitimate.
- My bills are [almost] all paid automatically.
- Credit cards always get at least their minimum payment, so I don’t have to worry about missing a payment