We know you have to save. We know you have to invest those savings. We know that you have to generate passive income with investments. What we do not always know is that none of this is possible if we do not optimize our expenses before so that a surplus arises that allows us to make the leap from personal finance to equity finance.
In today’s column, we will distinguish 6 different types of expenses. Three are positive and we must strengthen them. The other three are negative and we must reduce them. In the end, we will propose an optimizing exercise and present the conclusions.
1) Required expenses: Which ones fall into this category? To answer this question, the first thing we should know is that there are the desired expenses, those that are not strictly necessary to live. By contrast, the necessary expenses are related to housing, health, food, taxes on “necessary goods” and transportation, among the main ones.
It is very important here to avoid self-deception: many people prefer not to submit to self-criticism and fall into this category several of their desirable expenses simply to justify them.
On the other hand, while they are vital, the necessary expenses should not be overstated. For example, the cost of renting housing should not exceed 30% of our income. Finding a house or apartment whose rent suits our pocket and not vice versa is clearly our responsibility.
2) Smart expenses for enjoyment: A life composed only of necessary expenses is not life. It is important to give us some tastes so that everything is not working. But beyond right in spending so that it generates enjoyment, the acquisition of a good or service will be intelligent when the impact it has on our personal finances is limited and has been planned.
Most of the expenses financed by credit cards do not fall into this category no matter how much we enjoy them at the moment. This is because they generate a high cost that we will have to take care of. Smart expenses for enjoyment are paid in cash, after having saved for such purposes.
I regret the cold water for the reader who has been shining his credit card with the advance of the summer holidays. If you are thinking about how much to spend in the 2020 season without your personal finances falling apart, this column can serve you.
3) Smart expenses for investment: It is always convenient to be clear if we are facing an expense, where what is acquired is consumed almost at the moment, or against an investment, where we spend today to benefit tomorrow. Examples of smart expenses for investment could be a language course or any other educational plan that provides us with resources, the gym fee whenever we are followed, an advance of necessary or current consumption, the purchase of low-consumption appliances that reduce our spending in electricity, social work, car insurance, etc.
1) Hidden expenses and derivatives: In the column last week, we warned that there is no free lunch on Wall Street, which means that they give us very few things in life and that we must be very attentive to the hidden concepts they charge who take advantage of the lack of a financial culture of the population.
On the other hand, the derivative expenses appear, which they are called because they derive from a primary expense. For example, if I buy a pet I have to weigh not only the acquisition cost but also the maintenance cost (food, veterinarian, etc.). The same goes for a car, a motorcycle and an apartment on the Coast, for example.
2) Ant expenses: We talk about those less visible but more treacherous money expenditures in the field of personal finance. Some examples of small expenses that magically disappear from domestic accounting are the taxi, compulsive purchases, cheap memberships that we do not use, commissions for using ATMs of other banks, small installment payments with credit cards, cards additional credit that is little used, maintenance of bank accounts that are over, health insurance for trips that are paid all year and are used only for a month, cigarettes, meals not always desired away from home, the soft drinks on the way, the coffees, the kiosk sweets, take to wash the car very often, the bijouterie, the disposable handkerchiefs, the snacks, and the lottery tickets. They are all imperceptible expenses that can represent up to 25% of our monthly budget.
3) Deferred expenses: Wanting is equal to postpone because when we materialize what we want, the game is over. Desiring a lot and looking for ways to achieve it without despair stimulates creativity, so we can deduce that the opposite (quickly obtain what is desired) goes against our inventiveness and our imagination. If we have the credit card at hand, the anxiety calms down, but a different and more harmful problem appears. Deferred expenses are mainly credit card expenses. What is to be paid later is enjoyed in the present. When we have to pay it, the enjoyment will be gone and, instead, we will run into “the debt trap”, that labyrinth of personal finance that is often difficult to get out of.
Exercise and final conclusion
Now that we know 6 different types of expenses it is time for you to take a pencil and paper (or, better yet, an Excel spreadsheet) and classify your expenditures thoroughly.
Once you reach the total amount of money spent on each item, what follows is to calculate the share each one has in the total in order to know better the destination you are giving your money. If you need help calculating the percentages, review this column.
90% of your expenses should be placed in the positive column. Otherwise, you have a clear objective to accomplish: clean up your finances by checking every month the progress you are making, so that by the end of 2020 you can verify that you are reversing the situation.
“I don’t know how my money is going” is a phrase that, with the necessary knowledge, you should stop saying.