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Financial Friday #118: Time to Get Your Household Spending Under Control!
Household budgets are under siege across Canada as inflation spikes prices on gas, food, and almost everything else we need to record levels. In addition, rising interest rates have added hundreds of dollars to the mortgage if you have a variable rate or are looking at renewing a fixed mortgage. Many Canadians have been forced to cut back on their monthly spend to try and make ends meet but don’t know how to get started.
Budgets have a reputation for being difficult to sustain and it isn’t unjust, almost everyone has tried and failed at budgeting at least once. There are a lot of reasons for this, your budget may have been too strict and not realistic or maybe it was simply because it took too much of your time.
A lot of people start the budgeting process with trying to figure out how much they think they spend or might need and then try to live within those amounts. The fact is, most people don’t really know (or vastly underestimate) how much they spend. So, the first step to creating a realistic, sustainable-over-the-long-term budget is to track your current spending. You can do this in a number of ways, a mobile app or a piece of paper both work fine. It doesn’t matter which method you choose, just make sure it is easy and convenient to do so you don't forget.
Once you start tracking expenses you will soon see some that a whole pile of them are quite stable and don’t vary much (if at all) from month-to-month. This list includes the mortgage or rent, car or student loan payments, most utilities (some like gas or electric do vary seasonally), car or life insurance, and childcare. A second class of expenses are necessary items that fluctuate a little from month-to-month, like food, gasoline, and (essential) clothing.
The final class of expenses fluctuate wildly and are items that are discretionary or nice-to-haves.... but you could survive without. These include eating out, vacations, concerts or sports events, recreation, and non-essential clothing.
You can determine a basic monthly spend by adding up all the items in the first two expense categories. Put that amount of money into a chequing account every month and pay all those bills from that account. You don’t have to bucket each purchase to a category if you don't want to, but if you are running short from month-to-month and you are not cheating and using that money for non-essentials, you may have to up the amount. If you use a credit card instead of cash, make sure to pay those charges by the payment deadline with money from this account — no cheating!
Any money leftover after filling your basic expense bucket is not what you can spend, because you haven't saved anything yet! You need to fill two more buckets — your savings bucket and your discretionary or fun-money bucket. This is where it all goes sideways for most people. Taking from one bucket obviously robs from the other, so you need to find a balance between short-term gratification and long-term financial security. You also need to stick to the plan and lock away these amounts every month to succeed.
It isn't reasonable to follow some guideline that says put away "xx" percentage of your discretionary income because saving 30% of $500 is a lot harder than saving 30% of $5000. You are going to have to come to a conclusion yourself on what is livable when choosing between what you save and what you spend and aligning that to other financial goals like funding your retirement. Our only advice is that even if what you can save at the moment seems negligible, make that commitment! Did you know that just $100 month invested at 5% for a period of 30 years will give you an extra $100K for your retirement?
If your expense tracking shows that you are running out of money just trying to cover the basics, you need to go back and dig into your spending on necessities. There are some low hanging fruits here…. cable packages and cell phone plans are much easier to eliminate or lower than the water bill, and food is a huge expense that offers a ton of savings opportunities.
Food prices fluctuate wildly from week-to-week and from store-to-store. There are also cheaper substitutes on everything from what you BBQ (rib steak vs. pork steak... or marinade a cheap cut!) to your morning coffee (a large tub of Folgers vs those pricey Starbucks beans). Make sure you know your food prices so you can recognize a bargain when you see one (big-ticket items like laundry soap can be up to $8 cheaper from week-to-week) and constantly assess alternatives – there are lots of options at the grocery store.
What you consider essential clothing is also a grey area, your kids grow out of winter boots and need new ones — mom and dad can likely get another season out of their still functional but not so stylish boots.
If you are seriously in the red each month before even getting to your discretionary spend, then you need to dig into your fixed expenses. Number one on the hit list and a primary source of overspending is the car. Ideally, you want to keep the car payment and the related expenses (gas, insurance, oil changes, tires parking, etc.) to around 15% of your take home. Most people can afford much less car than they currently drive and turn to the never-ending lease or monthly payment to make it happen.
The other option for some families is to go from two cars to one. Before you say impossible; at least look at how you might make it work and how much money you could save. Car prices are extremely high at the moment and there has never been a better time to unload a used car.
Finding a cheaper place to live is an option and you can easily look around at what’s available if you are renting. If you own a home, there may not be many alternatives unless you really went overboard on your current home and there are viable options that make sense given the costs and effort involved. An easier option than selling would be to try and rent some portion of your home (a basement suite?) or maybe offer a spare room through Airbnb or as a homestay to an international student.
If you are already struggling with the mortgage payment, keep in mind that it could get much worse depending on your current rate, whether it is fixed or variable, and when you have to renew. The Bank of Canada interest rate hike on July 13 is expected to add about $55 a month for every $100,000 held on a variable rate mortgage and more interest rates increases are expected.
Credit card debt is another expense that is often overlooked because most people don’t fully realize how much of their money goes out the window each month on potentially unnecessary interest payments. If you are tapped out and need to use your card just to get by, then you need to dig into your fixed expenses. However, if a review of your credit card statement reveals a number of discretionary purchases over the past few months (or years!) that you are financing at 19.99% then you need to do two things.
The first is to get a budget in place and a system to keep your card purchases under control. Whether you give up on the card and switch to a monthly cash envelope is up to you, but you need to know exactly how much fun money you have at any given time and a system to keep that spending in check.
The second step is to reduce that card balance as soon as possible. Cutting spending is the first place to look for generating funds, but you may also be able to draw on the equity in your home or have some investments that you could liquidate and use that money to pay down your credit card. For reference, paying the minimum on a $1000 credit card bill will require more than 10 years and another $1000 in interest before you finally get it paid off.
Lines of credit are another area where discretionary spending may also go unchecked. Many LOCs are backed by home equity and have carried a very low variable interest rate over the past two years (especially compared to credit cards). The problem is that as interest rates spike higher, the interest on these loans will also start to bite more and more. At best, these loans will add years to your mortgage free date and at worst, you could lose your home entirely. A decline in home prices like we are seeing now may also cause lenders to look a lot more closely at equity-backed loans in the future.
If you are having trouble making ends meet and up until now have been getting by with fairly lose monitoring of your spending, it is time to dig in and put some controls in place. Tracking your monthly expenses and getting a handle on your monthly spend is a good idea even if you don’t have financial issues.
You don’t need to bucket every purchase into a complicated spreadsheet (unless that works for you!) but you do need to get a good idea of the total amount you absolutely have to spend each month. After that, you can figure out a savings plan and how much you have left to enjoy each month.
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