Sunday, 13 October 2013

Managing Expenditure

Saving is usually the first step towards achieving your financial objectives. One approach of building up savings is to have additional sources of income. The other approach is to defer consumption to a later date. To manage my expenditure, I have tried several ways over the last 2 decades; some work and some don't quite work. Let's discuss the ways that don't quite work before discussing the ways that work.

Ways That Don't Quite Work

The conventional way to manage expenditure is to set a budget for the various categories of expenditure. After trying for several years, I have come to the conclusion that budgets don't work. It works well for expenditure that are regular, such as utilities, taxes, etc. But when it comes to discretionary expenditure such as recreation, social events, etc., the budget is sometimes exceeded. The main reason is that the budget does not come to mind at the time of spending money. By the time I remember about the budget, money is already spent.

Related to setting a budget is to record all the expenses made. By recording and compiling all the expenses, you can analyse at the end of the day/ week/ month whether the money has been spent wisely and if not, to remind yourself to spend wisely the next time. Again, it does not quite work. Regret only lasts for as long as I'm looking at the expenses. It does not last until the time of spending money.

Perhaps the only time that budget setting and expense recording work is near the end of the month. If the budget is almost exceeded, I would try to defer some expenses to the next month.Conversely, if I spend less in this month, I would bring forward some expenses from the next month so that more money is available for spending next month. This is usually done by topping some stored value cards that are regularly used.

Ways That Work

The ways that work in managing expenditure (at least for me) has to do with how we think about expenditure. There are 2 ways of thinking about expenditure. The first way is to think of it in terms of opportunity cost. When you spend money on certain items, it means that you can't spend on some other items. As investors, it also means that the money cannot be invested and grown. Hence, the opportunity cost to investors is usually very high. The higher the rate of return and the younger the investor is, the higher is the opportunity cost. As an illustration, I have a target rate of return of 10% per year. At this rate of return, money will double every 7.2 years. I have 27 years before reaching the retirement age of 65. So, every $1 today will become $14.81, say, $15, when I retire. That means that for every $1 I spend today, I will have $15 less when I retire. Hence, the price tag of every item today is multiplied by 15. A mid-level digital camera that costs $2,000 to most people will actually cost $30,000 to me. That is a lot of money! From this perspective, I would think very hard about spending money on big-ticket items.

The second way of thinking about expenditure is to think about the amount of hours you need to put in at work to pay for the item. Let's say the expenditure is equivalent to 2 weeks of salary. Instead of the company paying you a monthly salary and using part of the salary to pay for the item, would you be willing to work for FREE for 2 weeks and at the end of the 2 weeks, the company gives you the item? Bear in mind that during these 2 weeks, you will need to endure the usual scolding from the bosses, tight deadlines, office politics, etc. Very likely, you will think a little longer about spending the money.


Generally, my experience is that if you manage the big-ticket expenditures well, you do not really need to worry too much about the small-ticket expenditures. You might overspend on the small-ticket items, but they will not blow a big hole in your pocket. Managing expenditure is not about being a miser; it is about knowing when to spend.

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1 comment:

  1. Agreed. 80-20 rule.

    We just need to track big ticket items spending and don't need to sweat the small stuff.