It was my first time riding in a Black Hawk helicopter. It was 2008. I was naturally a little nervous as the skids left the earth below me and the cool air above Fort Lee blew through the open doors. The whirring blades above were deafening.
I was competing to be named the Soldier of the Year for the Department of the Army, and this was the beginning of the land navigation event. I was given set of target coordinates and three hours to locate each of my points.
The Black Hawk touched down for only long enough for me to step off into a meadow. It took off, and I watched as the helicopter disappeared behind the treetops.
There I stood. Compass, protractor and pencil in hand. I plotted my points and readied myself for the journey. There was only one problem…
I didn’t know where the hell I was.
Triangulation. Not Just For Land Navigation.
Triangulation is a land navigation method where you shoot azimuths toward known landmarks around you, like antennae, hilltops, or fire towers. Then, you calculate the back azimuths (add 180 degrees) and plot those lines on your map. If you’re good, it will end up looking something like this:
It’s never going to be perfect, but it’s better than starting off blind. The principle of triangulation is simple: before you take a step, you first must know where you’re standing.
Such is the case with reaching financial independence, or with any financial goal, really. If you don’t know where you are, it’s very difficult to know if you’re moving in the right direction.
What’s The Point in Tracking Finances?
I’m going to assume that you want to feel in control of your finances. Stressing about money, as 64% of Americans do, is not a good look. Control is the first step toward removing that stress, and knowing your numbers is the first step toward exerting control. Once you know what you’re controlling–expenses, savings, investments–then you can start taking action.
The financial independence equation is not that complicated: investable assets must be 25x your net expenses (expenses minus current passive income [pensions, royalties, etc.]). If you aren’t tracking your investable assets or your expenses, it’s going to be pretty hard to ever declare financial independence. You might be standing on your mark and not even know it.
I’ve been tracking my net worth since 2004, but have only kept a historical record since December 31st, 2011–so just over four years. My wife and I had recently gotten married and just closed on our home two weeks earlier. After being buried in paperwork for weeks, I felt like it was a good time to see where I stood on everything–about $150k in the black. From that point, my net worth has gone up by about 25% per year, and it sits at just over $375k today.
I’m still amazed that I increased my net worth while spending twice my income for a year in NYC. Thank God for the bull market, I guess.
Anyway, while I’ve been tracking net worth for a while now, I’ve only been tracking my expenses for 18 months:
Not exactly the picture of stability, is it? Expense tracking became a necessity for two reasons: 1) Retire29 was born, and I felt the need to keep myself accountable (all my financial reports are here), and 2) I was spending so much money living in NYC that I had to take a serious look at how long I could go before I claimed bankruptcy, liquidated my IRAs, or was forced to sell our house.
There are lots of other reasons you should track your finances, though:
- Tracking finances, particularly expenses, helps prevent or quickly identify theft or fraudulent charges.
- Knowing where all your money is (with usernames/passwords, etc.) helps the “non-money” spouse settle affairs in the event you die or become incapacitated.
- Knowing your net worth, with all pertinent assets, makes estate planning much easier.
- Tracking finances makes it possible to set, and achieve, financial goals. What you measure is what you get, of course.
What You Measure Is What You Get
There is a term in Six Sigma analysis that goes, “What you measure is what you get.” When Gordon Bethune took over Continental Airlines in the early 1990’s, his airline was near the bottom is just about every customer service metric you could think of. To try to turn things around, he would send to every manager a monthly letter that showed the on-time statistics of the airline. Bethune wanted to ensure that timeliness was at the forefront of every employee’s mind at all times. This concentration bled into the whole organization: seating methods were changed, more pilots were kept on standby, check-in and ticketing procedures were streamlined, maintenance procedures were more standardized, and on and on. (Related Note: Bethune wrote a great and short book about the Continental turnaround, which I highly recommend reading.)
When you start measuring your finances, your natural inclination is to want to show improvement. You filter your everyday decisions through the lens of “how will this affect my expenses or net worth this month?” and you act accordingly. Eventually, that filter becomes less of a decision and more of an embedded behavior, but getting to that point still requires tracking at the outset.
When I began tracking, I grew tired of seeing ridiculous numbers for our cell phone bills, so I dropped them from about $110 to $10 today. I killed our satellite TV subscription. I started cutting my own hair. We began credit card churning to greatly decrease travel costs. I continue to aggressively pay down our car notes. We use gift cards for much of our dining. I get big savings at home improvement stores. And the list goes on. We’re now spending about half of what we were spending 18 months ago, and we’ll try to cut that in half again (largely from a paid-off home) by the time retirement comes.
What Is “Tracking Finances,” Anyway?
Let’s cut to the chase. What do I mean when I say “tracking finances?” Well, I mean you should keep a balance sheet and do a monthly expense report. There’s nothing wrong with also tracking your income. Tracking income is especially useful if you’re trying to set up a budget. I think budgets are generally a waste of time, so I don’t bother. I stick with Paula’s idea (From AffordAnything) regarding the anti-budget. What’s more, my income doesn’t change from month-to-month, so it wouldn’t be very useful to track.
I’ll take Balance Sheet and expense report one at a time.
On the evening of September 12th, 2001, Howard Lutnick, CEO of Cantor Fitzgerald, met with his other surviving executives in his Manhattan home. Cantor Fitzgerald, more than any other company, was utterly devastated by the 9/11 Terrorist Attacks. Over two-thirds of their 960 employees perished in their offices on the 101st-105th floors of the North Tower. Despite the almost unconscionable human toll, every record of the company was essentially wiped out. No accounting. No legal. No HR.
At this meeting, the first order of business was to put together a balance sheet.
While a grim example, this should illustrate the importance of knowing your financial position. Your book value. Your equity. Your net worth. In the same way as any business would, every household should keep a working balance sheet. A balance sheet is a comparison of your assets and your liabilities, the difference is your net worth (or, for a business, the equity or book value). You would think this should be a straightforward matter, but take a look around the financial blogosphere, and you’ll discover that it is anything but.
Here are the standard items that I would include and how I categorize them:
- Checking/Savings Balances
- Cold, Hard Cash
- Money Market Accounts
- Traditional and Roth Individual Retirement Accounts (IRAs)
- Taxable Brokerage Assets (includes stocks, bonds, ETFs)
- Annuities (at Cash-Out Value)
- Investment Property (Equity)
- Employee Stock Ownership Plans
- Real Assets
- Primary Home
- Restricted Accounts
- Flexible Spending Account (FSA)
- Health Savings Account (HSA)
- ESAs/Coverdell Savings Accounts
- Unpaid Dividends (after Ex-Date)
- Wages Earned but Unpaid
- Cash-Out Vacation Days Value
- Personal Loans Receivable
- Current Liabilities (< 1 Year)
- Credit Card Balances
- Personal Loans Payable
- Long-Term Liabilities (> 1 Year)
- Car Loans
- Student Loans
Easy enough, right? Wrong. Us financial bloggers can’t seem to agree on anything, so I’ve seen a lot of variations to the above. On the assets side, some folks exclude their primary home. Some folks include things like watch collections, cameras, art, antiques or rare coins. I’m probably alone in including most of those receivables, but they all seem reasonable to me (I have legal right to all of them).
For liabilities, I’ve seen people include unpaid bills or taxes due. I suppose that would be useful if you are in arrears on either, but if you pay them on time (or have estimated taxes withheld from pay), then I don’t see a reason to include them.
If you are unsure whether to include or exclude something, look to the book definition of “asset” and “liability.”
If that still isn’t clear enough, refer back to the reason why you’re tracking in the first place. For me, I want to feel in control while also keeping a passing eye on my march toward financial independence and my ability to retire. Because I’ll be selling our current home and at least one of our cars before retirement, it’s important to me to keep those on the books. For yourself, if the asset or liability could affect your financial situation, then probably include it (at least until you realize it’s not important or is immaterial).
I went ahead and made an example spreadsheet for anyone to use, if they wish.
Monthly Expense Report
Tracking your expenses is probably the most important thing you can do on your path to financial independence and early retirement. Despite the “80% of your pre-retirement income” rule of thumb that gets bandied about, all that really matters is what you spend. If you have investments that exceed 25-times your expenses, then you are safe to retire and are considered financially independent.
Beyond just the FIRE goals, tracking expenses is great for seeing where money leaks are, if any fraudulent or questionable charges hit your accounts, and allows you to identify areas where you can make improvements. Frankly, I couldn’t imagine not tracking expenses. It would feel crazy if I couldn’t answer, “How much do I spend on groceries each month?” Maybe not exactly, but within a couple standard deviations.
So, how can you track your expenses? Well, I’ll first say that once you get the hang of it, it becomes pretty easy month-to-month, especially if you only use one checking account and one or two credit cards.
I classify my expenses in the following categories:
- Car Note
- Health Insurance
- School/Work/Business (Not Reimbursed)
I chose the above categories because they gave me enough granularity to where I can see distincitive types of expense areas, but no so much granularity that it becomes ineffective. Obviously, every life and every household is different, so we all will have different buckets of expenses.
I used to hate tracking expenses, not because it was burdensome, but because the results were like a slap in the face every month. I’m spending that much on housing?!
Nowadays, tracking expenses feels pretty good. Mostly due to the fact that they are going down. I still took at problem areas every month and seek out ways to optimize my life.
Here is a Google Sheets spreadsheet to help you get started.
Can’t I Automate All of This?
I’m in the Len Penzo camp in believing that too much automation when it comes to your finances is not necessarily a good thing. Tools abound in helping you automate the tracking of net worth and expenses. You link all your accounts and, voila, pretty graphs at the push of a button that show everything under the fiscal sun. Mint and Personal Capital are the two most popular. I don’t use either.
Instead, I use good old Google Sheets and MS Excel. I find that this is actually easier (no logging in) and gives me more control. I’m adept enough with formulas that I have set up home values and car values so that I never have to actually update them.
More than that, though, is that using spreadsheets forces me to have an interaction with my finances. If everything is tracked without effort then you lose the close relationship with the dollars.
Len Penzo says it best, “when money management tools become too user-friendly, a lot of folks have very little incentive to understand the data being made available to them.” That about sums it up for me, as well.
Lastly, it takes very little time to get your monthly numbers together once you have a routine and process. Given the heavy turnover of credit cards in my family, having this high-touch approach also ensures that nothing (like a payment) ever gets missed.
Once you harness the inspiration toward wanting to change, or wanting control, or wanting financial independence, the next step is see where you stand.
Here’s one last link to that Google Spreadsheet I put together to help get you started.
Time to gain control. Good luck to you!