Do you find yourself spending over budget every month? If you cannot explain where your money goes, it's time to hit a reset button on your finances.
The traditional way of building budgets, both for businesses and individuals, is to use last year's spending as a baseline and then increase/decrease the budget for certain categories as required.
However, the trouble with this approach to budgeting is that you take the status quo for granted. You rob yourself of the opportunity to carefully think about every expense and evaluate whether it's truly necessary or not.
A few weeks ago, I built a budget spreadsheet for our post-FI life in Vancouver, Canada. This budget is crucial to our FI plan because it determines the size of our investment portfolio that's required to allow an annual safe withdrawal rate of 3.5%.
We have a pretty solid budget right now and our actual spending tracks closely to budget. However, since our post-FI life will be in a different city, we went back to the basics and built a budget from scratch.
The first step is to create a vision for what kind of lifestyle you want to lead. What neighborhood(s) do you want to live in? Do you need to be close to public transit? Will you own a car? Are you planning to have more kids in the future? Do you care about the school district you live in?
Once you have this vision, you can start fine tuning the details. I wrote down all the major categories of expenses we currently have, and did some local market research to fill in the blanks.
We used Padmapper.com to look at current rental ads in Vancouver to get a feel for the rental market there. Mr. Frugal Hacker's parents live close to Vancouver in Burnaby, so when we move back, our plan is to stay with them for a few months while we scout out below-market rental places. Currently, we have budgeted $1,650/month for rent. Vancouver is a high cost of living area, especially for housing. Rent has the highest impact on our annual budget (~50% of annual expenses), so we are flexible with our housing requirements list, especially since renting is only a 1-year commitment.
In our working lives, we get free lunches at work many times a week so our grocery spend is only $200/month. To estimate food expenses for post-FI living, we multiplied our current grocery spend by a factor of 2, to account for more meals at home. We also decreased our restaurant/coffee shop spend substantially since we'll have more flexibility and time to cook at home.
Our transport needs will look very different once we're not working. We won't be needing Uber/public transit to commute to work every day. However, we might decide to get a car in Vancouver to enable us to live farther away from train stations (thereby saving on rent). The catch is that car insurance in Canada is much more expensive than it is here in the US, so to be conservative, we included the cost of insurance ($2,500/year) and an estimate for gas costs in our budget.
Cell phone, internet and gas/electricity are essentials. I looked up cell phone and internet plans with Rogers to get a rough ballpark. We'll definitely scout out deals once we're there, but using numbers from Rogers gives us a good ceiling to use in estimates. Vancouver has colder winters than San Francisco, so I figured we'll likely be spending more on heating. I plugged in our numbers into an online cost of living calculator (like this one) to get estimates.
This is the bucket of spending allocated towards clothing, shoes, electronic gadgets etc. This type of spending is harder to budget for since it's completely discretionary. In our case, moving to a new city gives us an opportunity to reset our buying behaviors. We want to take advantage of this and embrace minimal living more deliberately.
Mr. Frugal Hacker has always been frugal, but I have a history of teetering towards retail therapy and lifestyle inflation. We moved to San Francisco in 2013 with two suitcases each. Four years later, we managed to fill a three bedroom apartment with stuff (mostly thanks to me). A few months ago, we spent an entire 3-day weekend decluttering. We gave away a barely used dining table set, sold my Canon DSLR camera, donated many bags of clothing, and got rid of the things around the house that we just didn't use anymore.
Throwing things away is extremely wasteful. It's not only a waste of money, it's also a huge waste of resources used to manufacture and ship the product. Being wasteful is pretty much the opposite of being a Frugal Hacker, so none of that shit anymore. Rather than buying stuff only to throw them away later, it's better to not buy them in the first place.
I've budgeted $600/year in this category, mostly to provide a buffer for expenses that we don't have the foresight for right now. We still need to replace our jeans and shoes once in a while :)
I budgeted $0 for travel. Travel is another completely discretionary category, and we don't have any "required" trips each year. We'll likely do smaller road trips/hiking and camping trips within BC. Since we're planning to have a car anyway, the incremental cost of these trips will be minimal so we didn't budget separately for this category.
The only entertainment subscription we pay for now is Netflix and the occasional movie theatre tickets once every two months or so bought using discounted Costco tickets. We have pretty low cost hobbies (cycling, hiking, blogging, board games), so our entertainment budget has been pretty bare bones.
We are incredibly grateful for Canada's single payer healthcare system. We will still have copays, but the costs are significantly cheaper than here in the US.
We researched BC's medical services plan copays and looked up estimates for extended healthcare insurance (dental, vision and prescription drugs are not covered by the government sponsored health plan). These numbers are fluid and likely to change between now and our move to Canada, but we budgeted $4k a year for this category.
We don't have children now, but we baked in a buffer in our budget for potential childcare expenses. Diapers, toiletries, medicines/first-aid, clothing and toys — all-in-all we decided to budget $1,700 per year. We don't have past experience here, but Canada gives low-income parents many tax benefits for childcare so we're hoping any under budgeting here will be offset by those tax credits.
I'll revisit this category again if in fact our pattern changes (i.e. if I get pregnant sometime between now and FI).
Our only expense in this category is our blog hosting expense which is under $100 a year.
Here's what the end result of this exercise looks like for us. The following is a future post-retirement budget. I have sorted this list in decreasing order of size of expense, and it's no surprise that housing tops this list at 52% of total expenses. We currently spend 59% of our expenses towards housing here in San Francisco. If we were okay moving to a cheaper city in Canada post-retirement (such as Calgary, Edmonton, Montreal, Ottawa, etc.), we could slash our housing expenses considerably.
Once you've built your zero based budget from scratch, you should do two things:
- Ask yourself: What have I missed? Were those items deliberately left out of the budget or accidentally forgotten?
- Compare your budget to your most recent spending to analyze budget vs. actual expenses. What are you spending on now that you didn't realize you were before you made your budget? If it didn't make the budget, should you be canceling that subscription now? If you didn't even know you had that service or subscription, do you really need it? :)
Following up with these two action items is what makes zero based budgeting so powerful. Traditional budgeting lets you take control of your spending by making tiny, incremental changes to your spending habits. This works well in some cases, but it will fail you if are caught in the hamster wheel of lifestyle inflation. Why remodel your budget slowly when you can re-architect your life from scratch and build your finances from the ground up?
This is what we suggest, and this is what we have done for ourselves in the exercise above.
Feel free to share your thoughts in the comments section below.