Remember, your income is an estimate. Your expenses are facts. If you have a discrepancy between them, it’s a fact that your income is wrong.
The goal of accounting is to know how much you have and how much you owe at any given time. It may seem natural to have a different system for tracking each of those things, but it isn’t. The same system works for both.
The difference between your income and your expenses is the amount you’ve either saved or spent. So track every penny as if it were part of one of those totals. Save one part of what you make, and spend the rest; don’t separate it into two streams inside your head.
If you need to change your life, one thing you should start with is accounting.
If you want to lose weight, the first thing you do is step on a scale. You can tell if you’re making progress just by looking. But if your goal is to increase your net worth–to make more money or grow your investments–you can’t possibly know if you are succeeding without keeping track of every penny.
How much do you make? How much do you spend? Where does it all go? Until you know, it’s hard to make any other plan.
Here’s my advice to everyone. Keep track of your money. Don’t just glance at your bank statement once a month; do it every day. If you need motivation, try this: set up an alert in Google Calendar for “Today + $5.” Every day that you don’t see $5 go out, you know that you’re saving $5.
Why $5? Because when I started doing this, I found myself spending $0.50 here, $1 there, without ever thinking about it. Now if I spend less than $5 I feel like I’m winning.
As a child, I had no sense of money. My parents were both teachers and we always had more money than we needed. If I wanted to go to the movies on Saturday, my parents gave me a dollar. I didn’t keep track of whether it was a dollar from my allowance or from my savings; it was just a dollar.
There was no reason for me to know or care how much each thing cost. But when I got older and earned some money, it became important to keep track of where it came from and what it was spent on. And when I had enough money coming in that small differences mattered, I decided it would be helpful to know what things cost in absolute terms, not just in terms of how many dollars I could get away with spending.
My needs are pretty simple: food, shelter, clothing, transportation, entertainment. So if I spend $200 per month on entertainment, that means I can afford $50 for dinner at a restaurant every week ($200 monthly). That’s a ballpark figure; if a restaurant is really great or really bad, I might go more or less often than once per week. But the number tells me how much is left for everything else.
Most money mistakes aren’t made by not knowing the numbers; they’re made by not having the right numbers in the first place.
If you want to make money, you have to track your income and expenses carefully. You have to know how much money you have, and where it’s going.
You have to do this every day, or even more often. If you don’t, then when it’s time to make a big financial decision—whether to change jobs or move or buy a house—you won’t really know if you can afford it. And you won’t have accurate information on the costs associated with various options: Are you going to be able to afford a new car? Are you going to be able to stay in your neighborhood if you change jobs? What would your new commute be like? What would moving cost?
I’m not saying those decisions should be based on cold-blooded calculations of net present value. But they should be based on good information about what your financial situation is now and what it will be in the future. And that means tracking your income and expenses as accurately as possible, as often as possible.
In theory, you should keep track of your expenses to make sure you’re not spending more than you have. In practice, you’re going to lose this battle. Most people can’t even remember all their purchases for a single day, far less what they spent a month or a year ago. So you’ll either spend too much or feel guilty and cut back too much.
The solution is to stop worrying about how much you’re spending and focus on how much you’re saving. Instead of thinking about how much money is in your bank account, think about how much you’ve saved by not buying things. (Don’t include everyday things like food and gas; it’s the money you would have spent on things that, if it were up to you, wouldn’t exist.) If you get in the habit of doing this every time you get paid, it will soon seem normal — like breathing or blinking. It will also push your savings rate way up.
At Home Depot, I use this strategy on my Home Depot credit card. I never carry a balance on that card.
When you do this, you can’t ignore any purchase; it’s like balancing your checkbook with a microscope. You’ll find yourself saying: “Wait, did we really use $9.75 in paper towels?” But you’ll also find yourself asking: “Wait, was that extra insurance worth $93?” The more closely you look at what you’re buying, the more careful you’ll be about how much of each expenditure really matters. You’ll get used to thinking about how much things cost and what they’re worth.