Saturday, October 28, 2017

The True Cost of Monthly Spending

Hello everyone, Mr. DebtFree here.  In this post I will show you how your unnecessary monthly spending could be delaying your retirement for years and costing you hundreds of thousands of dollars.  We will use my imaginary friend Frank's spending to illustrate this idea.

First some quick math.  Here is how much we need to save to cover a $1.00 per month expense.

1.00 dollars/month *12 months / 0.04 = $300

This means if I put $300 into a stock account, using the 4% rule I will cover that 1 dollar per month expense forever.  The quickest and easiest way to calculate how much you need to save to cover a monthly expense is to multiply the expense by 300.   After all, the goal here is to retire with enough money saved to cover all of your monthly expenses.

If I cut the expense and instead save that $1.00 per month in an investment account earning 7% interest over 20 years, I will have an extra $403 in a taxable account and $508 in a tax advantaged account like a 401k or IRA.

Let me repeat that, for every $1.00 you save per month and invest you need to save $300 less dollars in retirement AND you will have $403 more in your account 20 years from now.

By cutting a single $5.00 per month coffee you would need to save $1500 less in your retirement account and by investing it you would have $2015 more in your account 20 years from now.

Let's investigate this on a larger scale for my imaginary friend Frank.

Frank buys $3.50 worth of snacks at work every day.

He has cable T.V. which costs an average of $103 per month

His car insurance runs an average $72.17 per month.

He has a storage unit for his extra junk that he hasn't touched for years costing him $100 per month.

He grabs a spiced pumpkin latte at work every day for $5.00 and he and his wife splurge on coffee once each weekend for $12.

He subscribes to the World of Wizards video game for $15 per month.

Frank eats lunch at work every day for $8.00, and consumes a 6 pack of craft beer each week for $11.

His doTerra essential oils membership and single 15mL bottle of mint oil has a monthly cost of about $22.58

He has a $50 gym membership that he never uses and commutes an extra 100 miles of unnecessary driving each month.

Lets break this down in table form so it is easier to digest:

The Monthly Cost category is what frank is currently spending for each item.  The true cost is how much he would have to save up in order to retire and support his spending.  The optimized monthly cost is how much Frank needs to spend to replace or eliminate these items.  The True Savings category is how much less Frank needs to have in his retirement account to be Financially Independent.

Let's look at how we can optimize this spending:

Instead of buying expensive snacks at work, Frank buys the same snacks at the grocery store for $20 per month.

Frank replaces cable T.V. with Netflix for $11.00 per month.

Frank switches to a lower cost car insurance.  I personally use MetroMile in the Pacific North West and spend about $36 per month to insure my car.  When was the last time you negotiated for lower cost car insurance?

Frank does away with all of his extra junk in the storage unit.  The items of most importance are stored neatly in his garage and all of the other things he donates or sells for some extra cash.

Swearing off expensive coffee Frank turns to Folgers for his coffee needs.

Frank decides that he no longer wants to play World of Wizards online.

Patting himself on his nice round belly Frank decides to cut his beer consumption in half.

Frank can't live without his fancy mint oil so he drops the doTerra subscription and picks up a bulk bottle like this from Amazon that lasts him most of the year.

Frank drops the gym membership that he never uses and decides to start walking and biking an extra 100 miles per week.  This is a double savings as it lowers his car expenses (~$0.592 per mile)

The numbers speak for themselves.  By incorporating these little changes into his life, Frank needs to save $206,805 less for his retirement.

Frank is planning on retiring after 20 more years of work.  He wisely decides to invest the money he is no longer spending.  Here is where things start to get really crazy:

By simply investing all of the money he is now saving, Frank will have an additional $282,039 in retirement.  This assumes a 7% interest rate which is approximately average.  This also assumes that Frank is putting the money in a taxable account.  If Frank instead rolls this money into his 401k or taxable IRA assuming he is in an average middle class tax bracket, Frank will save ~$355,275 in 20 years.

With some very simple moves Frank must save $206,805 less and will have between $282,039 and $355,275 extra when he goes to retire.  

Using the 4% rule the money frank has saved will pay him between $940.13 and $1184.25 every month for the rest of his life.

Now you may not have all of the expenses that Frank does, but surely you can optimize spending somewhere in your life and reap the massive rewards of saving.  When faced with the true costs of monthly spending it is quite easy to make changes and cut years off of your working life.

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