The amount that you spend is a critical aspect of planning for financial success, but determining this number is easier said than done. You can get a ballpark idea by trying to add up what you spend each month on groceries, gas, entertainment, rent/mortgage payments, etc., but that falls short in a lot of ways. First, there will always be expenses that you miss. Even if you rely on bank and credit card statements, what about that on-the-go sandwich you grabbed and paid for in cash? Or the few dollars that you put into a donation bucket? Second, we don’t spend the same amount every month. If you just bought a car or took a trip, your expenses will look drastically different in that month than in a month when you’re isolated at home.
Planning for the long term
For long-term planning purposes, it’s much more useful to take a top-down approach to determine the actual amount that you’ve spent over a longer period of time. With a top-down approach, rather than adding up all of your individual expenses, we look at how much money you earned, subtract what you paid in taxes or saved, and then we’re left with the after-tax amount that you spent in a given time period. That will give you a better understanding of your true expenses without having to track down every receipt or stumbling over the variability in your spending.
Suppose that Jack and Diane take home a total of $7,000 every two weeks. This means that they take home $182,000 per year. We use take-home pay because it tells us what you earn after taxes and retirement savings are already deducted. If any paycheck deductions are for items other than taxes or savings (e.g. health insurance premiums), those amounts can be added back in.
Of that $182,000, Jack and Diane contribute $2,000 per month to an investment account and $1,500 per month total to 529s for their kids. So that’s $42,000 per year of their take-home pay that they do not spend.
At the beginning of the year, they held $56,000 in cash (checking/savings accounts, CDs, money markets, etc.). At the end of the year, they held $48,000 in cash, meaning that they spent $8,000 of their cash. In addition, they had $3,000 in credit card balances at the beginning of the year and $14,000 at the end of the year, which indicates an additional $11,000 in spending (even though they haven’t yet paid for it).
So, the total amount that they’ve spent in this 12-month period is:
- Take-home pay: $182,000
- Investment contributions: – $42,000
- Cash spent: + $8,000
- Credit card balance increase: + $11,000
- Total amount spent: $159,000 (or $13,250 per month)
This calculation may get more complex if we add in items such as large tax bills or refunds, estimated tax payments, property sales/purchases, gifts, etc., but the concept remains the same. And we know that Jack and Diane won’t always spend this exact amount in a given month or year, but with this number calculated, we can work to plan for their long-term financial success with a clear understanding of their needs.
