In short, financial independence is a long and drawn-out process. What can truly speed up the process is cutting expenses. This is where the fourth step to financial independence – cutting expenses comes in. There is a term called OPEX in business. OPEX is short for Operating Expenses. Every business wants to cut the OPEX to get a better net profit or to free up cash for investments. If you adopts the thinking of getting a better bottom line, you can invest more and therefore earn more.
Based on the post i made on financial independence, i will be doing elaborate posts on all the 8 steps in my financial independence post. This post is covering the fourth step to financial independence, which is cutting expenses.
The reason you cut expenses is quite simple, to invest/save more. To invest/save more than you do currently you have to either increase income or cut expenses.
Based on step 3 to financial Independence, which you can read here (third step to financial independence), we established why everyone needs an emergency fund. The fourth step is to find and eliminate expenses you do not need in your life.
Cutting the Expenses
Now you have started tracking expenses, built a budget and started your emergency fund. You now have the power to increase your savings rate and build your emergency fund faster by cutting down expenses.
From you second step to financial independence where we created a budget, you can now work on the expenses which is to high. You have to determine what is to high, and what you think is fair.
You have to consider some different aspects of your budget when looking for expenses to cut:
- The unnecessary
- The unimportant
- The important which can be done differently
When it comes to saving, there is simply no easy way out. Saving is the quickest way to increase your saving rate or investment amount. Increasing income are typically a longer process.
Firstly, you have to look at unnecessary expenses. The unnecessary expenses is what you do not need. Like unused gym memberships, unused car(s), unused subscriptions, etc.
It is important you are honest with yourself. The unnecessary is usually easy to identify when going through your bank statement. For example, if you are taking the bicycle to work everyday, why do you have a car?
What tricks most people is that when climbing into your car it does not cost anything, while getting on the bus or train costs something. Therefore, you see them as expensive. But i will promise you this, if you took the bus or train, it would be significant cheaper in most cases.
Finding things you do not use in your budget should be a breeze. Normally when you see it you probably go “oh shit, i should have canceled that last month”. Then you forget about and say the same thing next month.
Cancel the subscriptions you do not use and stop signing up for things you do have a use case for.
The unimportant is what you like, but really do not need. This could be Spotify subscriptions. If you cannot achieve your wanted savings rate and you have subscriptions such as Spotify, you should cancel it.
- Can you live without?
- Can you find an alternative?
- Do you have something similar?
If you can answer yes to the three questions you should just get rid of whatever it is. Taking the Spotify as an example; (1) i can live without Spotify, (2) because i already have Tidal, (3) I have Tidal, but also use YouTube.
With this example, you just identified that you currently have two music services. They both costs money and does the same thing. Lastly, you found that you are also using YouTube which is free. I know that Tidal and Spotify is more convenient, in terms of all the features they provide. However, money wise, you should consider getting rid of Spotify and Tidal for Youtube.
Is It In The Budget?
It is okay to have unnecessary costs in your budget. Not everything should be made cheaper, unless you wanna go hard on being financial independent.
If you have the saving rate/investment amount you wish to achieve, there is nothing wrong with blowing money. It is only a problem if you are blowing money you do not have, or spend more than you wish to.
The Important Which Can Be Done Differently
Using the same example from above, you have to evaluate if you find it important to have two music services, rather than just one. If you have included it in your budget as absolutely necessary, then fine. Otherwise, consider to downsizing to only one.
Hospital visits, dental care, car maintenance etc. is important things which should be taken care off every one and again. Hospital visits and dental care should be included in your budget through insurances. If you have an insurance which does not cover the visits, you should have build it into your emergency fund.
Another important trick is to go there often, maybe once a year. It is much better to get a yearly checkup on you health, and have a way to prevent surgeries. This goes for both your general health and dental health.
When talking maintenance there is a lot that you can do by yourself, which does not need a professional. E.g. oil change on your cars. Go to YouTube and find a “How to” video on changing oil. This is way more cost effective than going to a car mechanic.
The 50/30/20 Budgeting Rule
The 50/30/20 budgeting rule is a common rule for creating budgets. It goes 50% to needs, 30% to wants and 20% to saving/investing. Financial independence are about high saving/investment rates, and therefore cutting expenses are much more helpful, than such a budgeting rule.
There is multiple things with this model i cannot vouch for. Firstly, if your housing and food costs more than 50%, there is no way to follow this model unless you cut in investing or wants.
While the 50/30/20 rule is a nice rule of thumb you cannot really use it when you are “younger”. Typically, when younger couples buy a home, they are paying more than 50% of their income to their new housing. With time this will of course decrease.
Furthermore, depending on how hard you want to go for financial freedom, 20% might not be enough. You might end up with a 30/20/50 budgeting.
Therefore, you need to find a budged that fits you, and not following some strict rules, ironically.
The fourth step to financial independence is cutting expenses. It is your job to determine how much should be cut. Most of the time you will find that a lot more than you think can be erased from your budget.
When thinking on your personal budget, try to think like a business. If business cannot manage their finances, they go bankrupt. If that is not a main driver for cutting expenses i do not know what is.
The three things to consider when cutting your expenses, is whether they are unnecessary, unimportant or important which can be done differently. Identifying each of the things that can be cut out of your budget, can help you to achieve financial freedom at a much faster pace.
However, you should also keep in mind, that you need a budget which fits your reflection on what you want to achieve. Going for a monthly savings rate of 10% is okay, if you are okay with it. You just need to plan for it.