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May 1, 2016

Retirement Planning Step 1: Review Current Spending


So far I’ve written mostly about how to save money in everyday life, which is helpful for retirement, but isn’t the hardcore retirement planning advice some people want. That changes now.

This post will be the first in a series that will give a detailed look at how and when you will be able to retire. I will demonstrate everything using my family's finances as an example.
Since the financial calculations surrounding retirement are so convoluted, I've condensed them into five simple steps:

Step 1:  Review Current Spending
Step 2:  Calculate Retirement Date with Current Spending
Step 3:  Determine How to Radically Reduce Spending
Step 4:  Recalculate Retirement Date with Reduced Spending
Step 5:  Consider Generating Income in Retirement

I really believe it is that simple, but let’s not get ahead of ourselves. Back to Step 1; Review Current Spending.

I have a feeling many of us don’t have a very clear understanding of our current spending.
I suspect a lot of people probably think they could live on $50,000 per year in retirement; however, if you look at your current spending and realize you are burning through $100,000 a year, your opinion might change.
As Peter Drucker said, “What gets measured gets managed,” and it is incredibly important to manage our spending. I personally believe spending is the most important factor affecting your retirement. It is definitely the easiest factor for us to control. You probably can’t increase your income by 30% overnight, but there’s a pretty good chance you could reduce your spending 30% if you really needed to.

Dramatically reduced spending is the key to becoming Fiscally Free. I think going through these five steps will make that very clear, so let’s get started by looking at my family’s current spending.

As I’ve mentioned before, I have been using Quicken for a long time, so it was pretty simple for me to compile this data. If you haven’t been tracking your finances, and particularly your spending, now is the time to start. Quicken is great, but new online tools like Personal Capital, which I recently tried, are pretty cool too. It's free and it will even let you pull in some past data, so you won’t be starting from today.

I wanted this to be as accurate as possible, so I decided to look at the last three years of spending. I could have gone back further, but the last three years most accurately captures our current financial situation (home owners), so I left it there. I added up our spending in various categories over the three years then divided by three to get the average annual spending. I then divided that number by 12 to see the average monthly spending. Here’s what that looks like:

Category
2013-15
Annual
Monthly
Bills/Utilities
 $      8,042
 $          2,681
 $              223
Cash Withdrawal
 $    11,740
 $          3,913
 $              326
Charitable Donations
 $          882
 $             294
 $                 24
Income Tax
 $    57,954
 $       19,318
 $           1,610
Car & Car Insurance
 $    38,049
 $       12,683
 $           1,057
Mortgage
 $    94,575
 $       31,525
 $           2,627
Property Tax
 $    22,315
 $          7,438
 $              620
Home Insurance
 $      2,286
 $             762
 $                 64
Home Improvement
 $    24,834
 $          8,278
 $              690
Household
 $      8,471
 $          2,824
 $              235
Entertainment
 $      4,395
 $          1,465
 $              122
Fees
 $          684
 $             228
 $                 19
Gifts
 $      5,029
 $          1,676
 $              140
Groceries
 $    13,520
 $          4,507
 $              376
Dining Out
 $      9,311
 $          3,104
 $              259
Travel
 $    14,800
 $          4,933
 $              411
Healthcare
 $      1,105
 $             368
 $                 31
Personal Care
 $      1,284
 $             428
 $                 36
Clothing
 $      3,131
 $          1,044
 $                 87
Life Insurance
 $      1,011
 $             337
 $                 28
Total
 $  323,418
 $     107,806
 $           8,984

For something a little more visual, here’s what that annual spending looks like in a pie chart:

As you can see, our annual spending is almost $108,000. Any income beyond that amount is going to savings.
That level of spending is higher than I expected, and I’m guessing your spending will be higher than you expect too, but that’s OK. This will give us something to do in Step Three.

The obvious downside of high spending is that it will require a much larger nest egg to be sustained in retirement, as we will see in Step Two, determining when we can retire if we maintain our current spending.

Let me know if you tallied up your current spending and were surprised by the results in the comments.


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1 comment:

  1. I had to quit adding...it gave me anxiety$ seriously some great information.

    ReplyDelete