Seeing the Financial Wood from the Money Trees

The journey to financial independence can seem like a never ending uphill struggle sometimes. If you’re not careful investment fatigue can hamper you motivation and stifle your progress.

However while it’s very sexy to talk about and focus on investments, the real problem most FI seekers face financially is expenses. After all it is the expenses that need to be paid at the end of every month.

Expenses should be the primary focus of anyone seeking financial independence.

Early on in my journey towards FI I found that my expenses just seemed so vast a thing that I couldn’t envisage a time when they could be covered by just investment income. As a household we are relatively high earners but also (as is usually the case) high spenders. There used to be about 7 different bank accounts being used to pay, direct debit, standing order, withdraw and generally relieve us of our hard earned cash.

Progress only really came when I simplified our accounts and started tracking and categorising our spending.

How I Track Expenses

I’ve mentioned it before on the blog but lets recap on how I track our household expenditure. 99% of our expenses these days go through 2 accounts:

1. An American Express Card (that pays 1% cash back on all purchases). This is used for all shopping where possible and paid off in full each month.

2. A Santander 123 account (that pays cash back on most utility bills and decent interest paid on the balance). This account is used for all direct debits/standing orders.

At the end of every month I download the transactions from both of these accounts and dump them into a spreadsheet. I filter out all of the internal transfers and then categorise all of the outgoings into around 10-15 types (e.g. groceries, health, travel, insurance etc). This process is made very quick by using vlookups in excel to categorise regular or reoccurring payments (e.g. direct debits, petrol, supermarkets etc).

Once this is done it becomes immediately clear where you money is going each month. While this is great to know and just by measuring this stuff you’ll almost certainly stop spending so much it doesn’t necessarily show you what is required to help you read financial independence.

The next step is to group the categories into one of four sections:

• Mortgages (including over payments)
• Savings & Investments
• Work related expenses (commuting costs, work related clothing etc)
• Ongoing expenses (pretty much everything else)

Now we’re getting somewhere. Now we can see what proportion of our income is going where, and for what purpose.

Before we embarked on our mission to live off the Money Tree the big thing that struck me when I looked at our monthly cashflow was that there was a huge amount of cash flow through our multiple accounts that I couldn’t make sense of. We’ve never been too wasteful, have always saved and invested but the complexity of it all didn prevented me from seeing what was really happening. However when I consider what will be required once FI is achieved the picture becomes a bit clearer:

• Mortgages
• Savings & Investments
• Work related 
• Ongoing (pretty much everything else)

Once FI is achieved the majority of the outgoings we currently have won’t be needed. But what is in that ongoing category? Well it’s things like utilities, car maintenance, food, socialising, holidays etc.

Since moving out of London we eat out far less than we used to and when we do, it is far cheaper. Our days of multiple exotic long haul holidays a year are over, we’re now much happier visiting remote parts of the UK and spending our time hiking or cycling rather than lying on a beach. We still don’t feel the need for a chelsea tractor and likely never will. We like home made, healthy low cost eating and don’t have too many expensive habits.

So what I see now in our monthly expenses spreadsheet is almost like an epiphany. If I strip out mortgage payments, over payments, savings, investments, and commuting expenses there’s not actually a huge amount left. Of course this…

If I strip out mortgage payments

is a little easier to say than do.

Murdering the Mortgage

By far the biggest slice of our household expenditure goes on the mortgage. Ignoring my rental properties (which are self sufficient/standalone from a financial perspective) a large chunk of our household expenditure is on mortgage payments, both regular and overpayments. For the last few years we’ve been in this low interest rate environment we’ve been overpaying our mortgage heavily.

When we started to overpay, we took the decision to leave our monthly payments the same no matter how many overpayments we make. So every month we automatically overpay more than last month, without really noticing. Rather than having cheaper repayments we’ve been reducing the remaining term of our mortgage. This has turned out to be a great decision.

In 2010 our minimum monthly mortgage payment was a shade under £1,000. Thanks to our manic overpaying, the current minimum monthly repayment is a more reasonable £337, a whopping £633 lower. So now if the sh$t hit the fan and we both got fired from work (before we get to fire ourselves of course) and our supermarket shelf stacking jobs couldn’t cover that £337, we could even convert our mortgage to an interest only schedule (on the same term) and only have to pay £150 per month.

In other words we’ve deleveraged ourselves massively and built in a huge safety of margin with regard to our home ownership. Of course I could have gone about things differently and pumped all of our overpayments into investments if I thought I could have gotten returns greater than the mortgage interest rate (which with hindsight I obviously could have). However those investments would have been taxed¹ which would have had a big impact on the profits they returned. What’s more the ‘return’ I get from every overpayment is 100% guaranteed, risk free.

In Conclusion

If you’re heading towards financial independence then you should try to truly focus on just those costs that will be encountered in your post FI life. Once you’re in the promised land you won’t need to invest, pay down or save so much each month. By calculating what your ‘ongoing expenses’ will be post FI, you’ll probably realise that you won’t need anywhere near as much income as you do now.

In almost all cases you won’t need to replace your existing income entirely because your expenses will dramatically fall once you reach your goal. For us the answer has become clearer over time as our spending pattern has changed – kill the mortgage associated costs and we kill most of our expenses. Do that and we’re almost FI.

Notes:

¹My ISAs are for long term income production not short term storage of capital destined to be paid to the mortgage company.