Try to keep track of your personal expenses for a few days. You’ll probably find it surprisingly hard. Here are some reasons why:
We don’t notice small expenses. When was the last time you had to stop and think about whether you could afford a $2 cup of coffee?
We don’t notice large expenses. When was the last time you had to stop and think about whether you could afford a $2,000 television set?
We don’t notice most expenses. When was the last time you had to stop and think about whether you could afford a $250 haircut?
We forget how we spend our money. A study by two Federal Reserve economists found that Americans have only “partial awareness” of their expenditures–and they are the people who wrote the checks! Would you be able to go over every check you wrote over the past month? How many could you describe in detail? We can remember even trivial purchases if they stand out for some reason–the first purchase with a new credit card, say, or the first purchase using coupons–but most purchases fade quickly from memory. Even stranger, we may fail to notice spending on things we think of as necessities–housing, food, clothing, transportation
In [the] long run, [the] most important [thing] you can do is keep track of your personal expenses. A good way to do this is to get in the habit of doing a monthly expense report, just as you might do a monthly income report. In my case — and I’m not atypical, I suspect — most months my income is the same as the month before, but my expenses vary a lot more.
The point of an expense report is to study your spending patterns over time. This allows you to see your weaknesses and make adjustments. Though many people think they know how much they spend on eating out, few realize that they spend more on eating out than they do on their mortgage or rent. If you keep track of your spending for a few months, you will quickly discover that most people vastly underestimate what they spend each month on “other” items.
When you look at your own expenses with open eyes, you may be surprised by what you see. Do you really need that coffee every day? What about your lunch? Or your cigarettes? Or your gym membership?
One of the best ways to keep track of your personal spending is to set up a separate bank account for it. Every time you spend money, transfer a little bit from this account to a savings or checking account.
Ignore for now the question of whether these accounts make sense as a matter of policy. Just look at them as tools for practicing habits of mind.
The key to making these accounts useful is to make sure that you put every expense into them. If you pay cash for a pack of gum, put the cash in the account and the gum in your regular trash. If you pay with a credit card or check, enter it into a spreadsheet along with the date and a description, then file a copy of the spreadsheet away somewhere—but not too far away, so you can actually find it when April 15th rolls around. And most important of all: don’t spend anything unless you have entered it into your personal tax account first. In other words, don’t start spending money until you’ve accounted for it by putting it in the account where you keep track of taxes on personal expenditures.
For a variety of reasons, I have been using a personal accounting system for several years now. It’s not very fancy: I keep my accounts in a plain text file, and I do all my calculations by hand.
What’s fancy is the way I use this system to keep track of my expenses. In fact, it’s so fancy that I wasn’t going to tell you about it until I’d finished fiddling with it some more and had made sure that it was going to work. But since I haven’t made any significant changes in the past six months, and since you’re probably not going to start using this system yourself any time soon, and since there’s no point in my hoarding all the good ideas to myself anyway, here goes.
When you are self-employed, your expenses are not tax-deductible. But you still have to keep track of them. If you don’t, the IRS will assume you are making much more money than you really are. That will make it harder to get a mortgage or a business loan.
You can deduct 100% of your health insurance premiums, including “Cadillac” coverage for things like dental work and physical therapy. You can also deduct 100% of your health savings account contributions, which can include payments into a fund that pays for big medical bills and then reimburses you with interest.
If your income is below $100,000 and you don’t have an employer’s health plan and don’t qualify for Medicaid, you might be able to get subsidized insurance on the exchange. And if it turns out that after factoring in subsidies and tax credits you still can’t afford insurance on the exchange, you can opt out of Obamacare and pay the fine.
If you want to buy medical equipment such as crutches or contact lenses or dentures, those are deductible too.
One thing not deductible is cosmetic surgery — unless it is medically necessary to fix something that would endanger your life if left untreated.
It’s harder than you might think. If you don’t write it down, you’ll almost certainly forget some of what you spent money on. And because you didn’t write it down, you won’t be able to make the case for a tax deduction.
There are two ways of doing this. You can either keep a running total for the year, or keep track of your expenses as they occur, but both work. The first is more convenient—you can do it once a month and be done with it—but the second has a big advantage: you’ll remember what you spent money on during the year. It’s easy to forget how much money you spent on food after a few months have passed, but if you’re looking at the receipts every time the cashier hands them over, it will be harder to forget.
If keeping track of expenses as they occur sounds too hard, consider that most people who try find they actually enjoy it once they get into the habit. There’s something strangely satisfying about being able to look back on an entire month and remember exactly where every dollar went.