If you've been trying for a long time now to get ahead financially but nothing seems to be working, it's likely you have massive expenses. Not all expenses are bad, but weeding out the ones that are and reducing overall expenses will set you up for financial success. That's what this article is all about.
First, you can choose to prioritize and control your expenses. Some expenses are far more damaging to your finances than others…Would it help to have a proven system of prioritization, so you know where to start?
Below, I've detailed four types of expenses in order of priority. You'll want to eliminate those at the very top of the list, while you'll probably decide you can live with those toward the bottom of the list.
Destructive Expenses: These push you toward poverty and away from prosperity. They include personal vices, like drugs and gambling. Credit card interest, most loan interest (except loans to purchase cashflowing assets—see Productive Expenses, below), and excessive bank fees (overdrafts, excessive withdrawals, etc.) are the most common in this category. Because financing on so many purchases is so easily extended by retailers, many of us have accepted these expenses as a regular part of life. But that's a lie. Financing everything with credit destroys your financial future and will keep you broke. You want to rid your life of destructive expenses entirely.
Consumptive or Lifestyle Expenses: These create joy and fulfillment in your life as well as memories, but they don't build income or assets. They're typical consumer expenses like going on vacation, buying new clothes, and your housing payment. It's OK to have consumptive/lifestyle expenses, as long as you manage them. Use cash rather than borrowing for these expenses (exception is a house you can afford to finance), and you'll be reducing some of that 34% of income the average American pays in interest every year.
Protective Expenses: These protect your property, health, and income, but generally don't earn a significant cash return. Protective expenses include your liquid savings, life/health/disability/auto insurance, your AAA membership, etc. They're often overlooked and under-prioritized because most people have the wrong money mindset and cut protective expenses in lieu of cutting destructive or consumptive expenses. When it comes to protective expenses, don't make the error of seeking lowest price instead of best value. When life doesn't go as planned, having protection you need and can count on is critical. This is not the place to cut corners in your budget.
Productive Expenses: These expand your cashflow and build assets. Examples are your business startup investment, personal development that increases your value to the marketplace, and financing the purchases of cashflowing assets. Productive expenses enhance your life. The opposite of destructive expenses, they push you toward prosperity and away from poverty.
Give it Some Thought
Isn't that helpful in learning how to prioritize expenses? Most people don't put any thought into this stuff, and it's killing their finances. Let me give you an example.
Do you know anybody who wouldn't hesitate to drop $10 on lottery "scratchers," but when it comes to car insurance they'll give up extra coverage or go with a no-name company for a quote that's $10 cheaper? Those are two completely different priority level expenses, and that person treats the lottery tickets like they're more valuable than the insurance.
How about the person who wouldn't dream of investing or borrowing $2,000 to start a home business which could add income to their life, but they'll take a $2,000 vacation to the beach and put the whole trip on a credit card, gladly subtracting income to pay for it over the next year at 20% interest?
Can you see how so many people have such a hard time with their finances? How powerful is it when you get educated on this stuff and decide to change the destructive habits?
Now that you have a solid understanding of expenses, I challenge you to do this right now (it'll only take 5 minutes—10 minutes tops). Complete a written (typed is fine, too) budget to give yourself a snapshot of where your expenses stand today. If you don't have one and don't know what it should look like, email me ([email protected]) and I'll send you one.
Now, utilizing the four types of expenses to prioritize, you can determine what to cut and what to keep. That's your homework this week. If you share finances with someone, get together and make the decisions. This is the hardest of the "how-to" steps in mastering your finances. Do it, and you'll be building discipline that serves you well in all areas of your life, not just money.
What Wealthy People Do
Need proof you're on the right track? Let's go over what wealthy people do and don't do:
- They DO hang around other people with good money habits. What are the money habits of the five people you hang around most?
- They DO track spending, both projected and actual, on paper. Do you have a written budget?
- They DON'T play the lottery. In stark contrast, 77% of poor people play the lottery every week. What kind of expense is the lottery?
- They DON'T finance their lifestyle with credit cards. What kind of expense is credit card interest?
- They DO keep their housing costs at or below 25% of net monthly income. How many people do you know who live by this standard? What kind of expense do you think housing falls under?
- They DON'T have a car payment.
And now here's the big takeaway. A full 94% of millionaires surveyed do these two things:
- They DO purchase quality, used cars (usually a two- or three-year-old car just off lease), pay with cash, and drive them until the wheels fall off.
- They DO save 20% of their income, faithfully, no matter what. By contrast, most American households don't even have $2,000 liquid savings. How about you?
Again, there's nothing wrong with having expenses. But it's important to prioritize what to cut and what to keep.
A 15-year veteran of law enforcement from the Kansas City area, Adam Doran is now a fulltime financial advisor who focuses on helping police officers achieve their financial goals. You can email him directly at [email protected].