You are often asked to keep track of your expenses. And there is no denying that it is a good and effective piece of advice.
Earlier, people used to note down all their expenses in notebooks. But it’s much easier these days. There are hundreds of free apps that you can download on mobile devices to track your expenses automatically.
But why is tracking of expenses considered important?
Because it’s the first step in understanding how you manage your money. And it helps create awareness about your cashflows. If you wish to create wealth someday, then you need to spend less than what you earn. This is the basic law of wealth creation. And if you don’t know where your money is being spent, then you won’t know what money habits you need to change to begin creating wealth.
Keeping tabs on spends
Tracking expenses is very important for those who find it difficult to save money and live from paycheck to paycheck. Once the tracking begins, you may identify some real leakages in your money outflows, i.e., unnecessary spends that can be eliminated without any unwanted change in lifestyle.
But is tracking your expenses enough? No, it isn’t. Why?
Think about it. Why do you want to track your expenses in the first place? Because you want to ‘not’ spend everything you earn and instead save some money for other things. Isn't it? And why do you want to save money? Because, you have financial goals for which you would require money later.
So, keeping the eventual reasons for saving – financial goals – in mind, the fact is that you also need to track investments.
But even before you begin tracking, you need to find out how much you need to save for each of the goals.
Let’s say, you undergo a goal-based financial planning exercise (by yourself or with the help of a good investment advisor) and find out that you need to save the following sums for multiple goals every month.
- Child’s Higher Education: Rs 10,000
- House down-payment: Rs 40,000
- Retirement at 60: Rs 15,000
- Some other goal: Rs 5000
That is, to fund all your goals and to ensure that the right amount of money is available at the right time, you need to save Rs 70,000 per month. The eventual goal for you is to invest at least this amount, if possible.
Now think about it for a moment. If you can save this much every month, then that means your financial goals are on track and whatever is leftover is free to be used as you wish. Right?
To put it more simply, you can say that as long as you invest enough for all goals, it does not matter how much you spend.
Investing more to reach goals early
Of course, there is a school of thought that pushes you to invest as much as possible and even more than what is necessary. But once you take care of the base case (of saving enough), it is up to you if you wish to save additional amounts to reach your goals earlier.
Some would like to do that. For example, those targeting early retirement. Others would may want to save just enough for all goals and spend the remaining amount.
Let’s extend the earlier example: Suppose you earn Rs 1.5 lakh a month. Regular household expenses are, say, Rs 50,000 per month. So you have Rs 1 lakh to spare.
From the earlier example, you need a minimum of Rs 70,000 per month for all goals.
That leaves Rs 30,000 as balance after all goal-related savings.
You have the following options:
- Start spending Rs 30,000 additionally every month
- Save more for retirement to target early retirement. So, you set aside Rs 45,000 for retirement instead of Rs 15,000
- Or, you take a middle path and spend Rs 15,000 and save Rs 15,000 additionally for early retirement.
Of course, there is a risk of kick-starting the habit of spending unnecessarily. And that is where another round of expense tracking can help.
But point to understand here is that it is not enough to track just your expenses. You need to track your investments for various goals. And you need to ensure that you begin saving the correct amount for each goal.
