Today’s topic is one of the most important topics in personal finance. This topic is simple at face value, yet it is one of the most misunderstood topics in finance. Today, we will discuss the subject of expenses.
When describing some situations, we hear terms like “the expenses just got out of control,” giving imagery of an unmanned firehouse flailing about. Untamed expenses can be as ravenous as a wildfire. The scariest part of all, most of us don’t even know how much we actually spend, and in this unawareness, expenses strike like a thief in the night. Expenses can also be distracting, drawing our attention to meaningless debits while the real monster expenses slip through the back door.
In former Thoughts On Money entries, we’ve covered the paramount importance of simply knowing how much you spend each month. Today, we will discuss the different types of expenses and which line items deserve more attention than others.
Off we go…
Bike-shedding (Small Expenses)
I don’t know if you’ve ever been a part of a board or a committee, but there is an interesting dynamic that happens in these settings, because everyone has a voice and an opinion, the most trivial decisions get debated and hashed out ad nauseum. It can be quite exhausting. Often, the BIG decisions aren’t prioritized in the agenda, and due to debate exhaustion and fatigue, there is a disproportionate amount of energy spent on the trivial versus the significant. C. Northcote Parkinson coined the term “bikeshedding” (also referred to as Parkinson’s Law of Triviality), where he describes a fictitious committee devoting an imbalanced amount of time and effort debating the construction of a bike shed versus the other topic of discussion, the construction of a nuclear reactor. Parkinson is simply concluding that people tend to devote more time to small decisions than warranted, and less time to big decisions than warranted.
Unfortunately, your personal finances are not exempt from the Law of Triviality. You find couples debating over small expenses – dining out at lunch too often or a morning Starbucks routine – and in reality, a change in behavior in these spending areas would have very little impact on the bottom line. Sure, you can find articles that talk about what that $5 daily savings could compound to over a lifetime, but trust me that these are not the decisions that are making or breaking a financial plan.
When it comes to your expenses, be careful not to “bikes-shed,” don’t allow yourself to give small expenses a disproportionate amount of your attention and focus. Don’t sweat the small stuff.
The Other Side of the Coin (Big Expenses)
Buying a new car, buying a new home, buying a second home, etc. These are BIG expenses. These happen less often, and in comparison to what I described above, these decisions deserve your undivided attention and focus. Negotiating the right prices and choosing the most appropriate financing options are worth your time and energy. These types of decisions will tip the scale on the financial plan and need to be made with prudence and wisdom.
A good and healthy exercise is to create a list of all of your expenses for a given time period (e.g., 1 year). This list will typically be sorted chronologically, but for this exercise, you will want to resort the list based on the cost of the expenses, largest to smallest. Adding a column that shows you what percentage the expenses (or expense category) was of your total spending is also helpful here. The goal is to build visibility and awareness around those top ten or top twenty expenses. Were you surprised by any that made this list? Do you feel like you were responsible for these purchases? Were these thought-out purchases made with patience or impulsive ones?
Remember, BIG expenses deserve your undivided attention as they have a BIG impact on the bottom line.
Hunting in Packs (Recurring Expenses)
I live in a small, sleepy beach town, and our house is a short walk away from our kids’ school in the morning. Lots of life, lots of energy, lots of kids, plus some rolling hills in the backdrop of our community. It isn’t where you’d expect to see a pack of coyotes, but sure enough, at dusk and dawn, you will see these guys roaming the neighborhood. They aren’t particularly intimidating on their own, but they hunt in packs. One evening, I saw our neighbor’s dog – a big dog – jump the fence to fight with a lone coyote, and the coyote just began howling and letting the big dog chase him back to the den. We were able to chase down the dog before it became prey to the pack, but it was a sight to see how that was all shaping up.
Recurring expenses can be a lot like coyotes. On their own, a single recurring expense can be innocent and harmless, but when viewed in the pack (the group of all recurring expenses), it can become a bit more dangerous. A good practice is to stay on top of the existing recurring expenses you have in place and ensure that all are necessary and in use. In the age of streaming, sometimes you can find yourself with redundant or unneeded services that you picked up in the past and forgot you were still paying for. Kids complicate this dynamic, as they may be ordering or subscribing on your behalf as well.
Be aware, be diligent, and be careful of the pack – on their own, they are weak, but as a pack, they can be deadly.
Collateral Expenses
These types of expenses are the sneakiest of the bunch.
You may operate in prudence and patience, do all of your research, pay a fair price, etc., but did you calculate the other expenses you will incur based on this new purchase? If you are buying an exercise bike, do you have to pay a subscription fee for the classes? If you’re buying an exotic car, have you already factored in the cost of insurance?
Buying a second home is an easy example. You aren’t just buying a second home; there are collateral expenses. You are also buying a second set of utility bills, paying another invoice for another landscaper, replacing another water heater, etc.
Collateral expenses don’t appear on the back of a napkin and are often an unpleasant surprise or simply the reality of some of these symbiotic expenses that exist in the real world.
One-Time Expenses
One of the trickiest parts about expressing your future expenses inside a financial plan is the lack of vision you have around one-time expenses. Based on the name, one-time expenses seem rare, but they are actually quite common. You probably have a unique one-time expense every few months. New tires, braces for your son, your daughter’s wedding, a new car, etc. When you make these purchases, the self-talk of this being a one-time occurrence is comforting, but these items are much more common than you would think.
To create a worthwhile financial plan, you need to be accurate or close to accurate on what the expenses are going to be. Because these one-time expenses can be hard to forecast, it may be wise to simply add a buffer to your estimated expenses. It’s like when you are mapping out construction costs on a new home build – whatever they say the cost is and the finish date, it’s best to add 25% to the cost and 6 months to the deadline.
It’s often these one-time expenses that show up in your top ten expenses for the year. Although each of these expenses can be considered unique, there is a certain rhythm and cadence for how often they surface. Be mindful, be aware, be diligent when it comes to one-time expenses.
An Expensive Lesson…
The Oxford Dictionary defines wisdom as “the quality of having experience, knowledge, and good judgment; the quality of being wise.” We can do our best to soak up all the knowledge we can, and we can surround ourselves with high-quality company to help us make good judgment calls, but in the end, experience is often the best teacher.
When I was in my 20’s I made a dumb decision on a car purchase – that experience and burn are still felt today. Although scars aren’t the most beautiful, they leave a mark, and they tell a story. We have these adages like “twice burned” or “Fool me once, shame on you. Fool me twice, shame on me” to remind us that wisdom is really learning from our experiences and avoiding repeat mistakes. Expenses are simply one of those areas where repeated mistakes often happen.
So, know thy expenses. Be aware of what you spend on a monthly basis, and be aware of those common expense pitfalls. As I opened up with, expenses and prudent expense management are perhaps the most important topics in personal finance.
