Category: Expenses

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Expenses Investing

Investing An HSA: Our Retirement Healthcare Fund

BLUF: Retirement healthcare expenses add up over your lifetime. Saving and investing all HSA funds before retirement gives you a large pot of money to cover many of those retirement healthcare expenses.

I’ve written previously about how powerful Health Savings Accounts (HSA) can be as a quadruple tax advantaged account. Given that you can save into an HSA with pre-tax money and then spend that money tax free on medical expenses, why wouldn’t you spend that HSA money today?

I’m looking to play the LONG game. Medical expenses as we age are one of the largest expected spending categories. In this article I’m going to help you understand some average costs for healthcare in retirement and some ways to use the HSA to cover those future costs. I’ll show you our plan to save in our HSA’s, invest and NOT spend them until retirement to cover those healthcare expenses.

Healthcare Costs In Retirement

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Note: all data in this section is from this HealthView Services report.

In the US paying for healthcare is one of the biggest threats to wealth building during our accumulation phase and preservation in retirement.

It’s a cost that’s hard to anticipate and plan for when you’re young. You’re likely in good health and expensive situations are infrequent. You don’t need a large line item in your budget to cover those expenses. As a 41 year old I had a number of procedures last year to investigate a GI issue and it cost me $3,150 out of pocket on our HDHP.

When it comes to premiums, they’re probably fairly affordable when covered by an employer sponsored plan. I’m fortunate that it only costs me about $100/mo for medical, vision and dental premiums and my company subsidizes the rest.

As you can see below, it can be rude awakening when transitioning from an employer sponsored plan to Medicare where you are 100% responsible for the premiums.

Average Healthcare Premium Cost Comparison of 64-Year-Old Couple (Pre-Retirement)
to 65-Year-Old Couple (In-Retirement)
**Medicare Parts B and D, and supplemental insurance Plan G.
Source – Table B

For a healthy 65 year old couple retiring in 2020, they’re projected to live until 87 (male) and 89 (female) and spend $387,644 in healthcare costs over their lifetimes NOT including long term care costs. Those costs include:

  • Premiums for Medicare Parts B and D, supplemental insurance (Mediagap), and dental insurance
  • Out-of-pocket costsrelated to hospitalization, doctor visits, tests, prescriptions drugs, hearing services, hearing aids, vision, and dental.

In 2020 dollars, this means that 65 year old couple would spend the following per year on healthcare.

Future Annual Healthcare costs per year for a healthy 65 retired couple.
Source: http://testing.hvsfinancial.com/hvsfinancial/wp-content/uploads/2020/03/Health-in-Retirement-Planning.pdf

This is all driven by 4.41% healthcare inflation costs per year in addition to you just needing more care as you age.

In a sick twist, the healthier you are, the more money you’ll need for healthcare in retirement. Why? Look at an example between a healthy 55 year old woman and one with type 2 diabetes. The diabetic pays more per year but because her life expectancy is 9 years shorter her lifetime healthcare costs are $266k compared with $424k. Yikes!

Source – table C: http://testing.hvsfinancial.com/hvsfinancial/wp-content/uploads/2020/03/Health-in-Retirement-Planning.pdf

Building That HSA Money Machine For Retirement

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Now that I’ve sufficiently scared you (sorry) with this future costs to plan for, it’s time to discuss some ways that an HSA can be used to cover these future expenses

Spend HSA Money On Current Medical Expenses

This is the most common way that an HSA is used. Similar to how people use a flexible spending account that doesn’t carry over year to year, many people use an HSA to pay for medical expenses on demand. Money goes in pre-tax and you can use it to pay your medical expenses tax free.

There’s nothing wrong with this approach. You get the tax savings of funding with pretax money and paying the expenses tax free. However, you’re effectively using the HSA like a checking account. Your money isn’t making you any additional money to pay for future expenses.

Let’s create an example where you have a 40 year old couple that just started their HSA’s with $0. They contribute the max $7,300 to their HSA’s for every year until they turn 65. However, they spend half of it ($3,650) each year on current medical expenses. The other $3,650 is invested getting a 5% real return (nominal – inflation) for 25 years. This is a bit conservative as historically this is 10% nominal returns and 3% inflation.

Over those 25 years you would have contributed $91,251 and it would have grown to $181,775 in todays dollars (net present value).

Certainly a nice chunk of change. That would cover more than half the average retirees medical expenses.

Pay Out Of Pocket For Medical Expenses, Invest the HSA

There is another way though. You could max that HSA and pay all your out of pocket medical expenses with after tax dollars instead of using the HSA money.

Why do that? Two reasons really:

  1. You’re giving more time for that sweet tax free forever money to compound.
  2. By paying your current medical expenses with after tax money you’re paying taxes today instead of making your future retired self pay income taxes to cover medical expenses (when your HSA runs out). Very similar to investing in a Roth / Roth 401k where you pay the taxes today and your future self doesn’t have to.

I think of it as taking one less risk out of retirement by letting that HSA grow as large as possible. After all, if you don’t need it you can always spend it on non-medical expenses and be taxed as ordinary income.

Let’s run the same scenario for that 40 year old couple except this time they’re going to save and invest the full $7,300/yr for 25 years.

With 5% real return you end up with a net present value of your HSA after inflation of…double! You contributed twice as much at $182,502 and that money doubled to $363,550. That’s pretty close to the $387,000 to the projected retirement healthcare expenses!

How sweet would it be to not have to worry about your main portfolio covering your healthcare?

Our HSA Investing Plan

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One reason that I love thinking through and writing about financial topics is that it makes me take a hard look at my own actions and see if I need to make a change in our own plan. This article is one of those cases.

Our Old Plan

For the last few years we’ve been paying out of pocket for all medical expenses and investing those HSA funds to let the money compound. I knew we would use that HSA money in the future, but I hadn’t thought through our planned time horizon and how we might use the money.

I had been investing our HSA’s inline with the asset allocation of our overall portfolio – roughly 75% stocks, 25% bonds/cash. VTI for a total US market index and TLT for long term treasury bonds. The bonds being for stability and in case we needed the funds. You can see that below in my HSA account. Mrs. MFI’s HSA investment account is invested similarly.

Our New Plan

Our new plan gets more specific on the planned time horizon to use the money and how we might use the money. And, because we have a plan for the money, an adjustment in the asset allocation.

Time Horizon: Use our HSA money starting at age 65.

Money Use: You can use HSA money for Medicare part B,C & D premiums so we’d use the money then. Normal medical expenses as well.

Asset Allocation Changes:

If you have 24 years (age 41 to 65) with no planned need to touch the money then there’s no reason for us to be in bonds right now. We have enough in cash to cover our HSA deductibles. As such, I’m going to move these buckets of money to a 100% stock allocation.

While the US market is great, and has been on a tear for many years, I think it’s prudent to mix in international stock exposure. I compared a VTI/VXUS (VGTSX is similar) mix to 100% VT (simpler) in portfolio visualizer to see how they compared. VT is 60% US, 40% international stocks so this is the true apples to apples comparison. The VTI/VXUS (VGTSX) outperformed by almost a percent per year compounding annual growth rate (CAGR) for the last 14 years (2008 – 2022).

Since I want to allocate a little heavier towards the US I’m going to go with 75% US / 25% international stock index funds . The past performance difference grows wider of course give the US markets performance although that doesn’t guarantee the future. It’s entirely possible that international markets perform better over the next 20 years but I’m not one to bet against the US.

So that’s what I went with and I executed that change this past week and moved all my bond positions into VXUS giving me a 100% stock allocation in my HSA. I’ll be changing over Mrs. MFI this week. VXUS is a low expense ratio (0.08%) international fund that invests in non-US equities.

This puts me right at a 75% allocation is the US total stock market with VTI and a 25% allocation in the non-US international stocks markets with VXUS.

HSA Growth Projections

We currently have $30,000 in HSAs at age 41. We plan to keep maxing out those HSAs at $7,300 total per year for the next 10 years. At a 5% real return (actual return – inflation) that would give us $144,000 in todays dollars.

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If we then kept that money invested for another 14 years, from age 51 to 65, with no contributions that money would grow at 5% real returns to $290,000.

At that point we would have glided to a more conservative 60/40 stock/bond portfolio. $290,000 in today’s dollars covers a good portion of the $387,000 in healthcare costs expected for a couple over their lifetime but there clearly is a shortfall.

It’s hard to find a calculator that lets you increase the withdrawals but this one let me add a % increase to my withdrawals through the use of the inflation adjustment. Since I’m using real returns inflation is already accounted for in the returns.

I put 6% for the expenses to increase each year which aligns pretty good with a 65 year old couple spending $12,000/yr and then that increasing to $21,000 by 75 and $34,000 by 85 (estimation provided earlier).

With a 5% real return we’d run out of HSA money at 87 years old.

Note: Withdrawal setup to start at $12,000/yr and increase at 6%/yr.
Calculator: https://www.tcunet.com/Plan/Calculators/Planning-Calculators/Investment-Savings-Distributions-Calculator

A small shortfall if we live that long that would need to be paid out from other money. Although, given how many assumptions go into these projections, this potential shortfall is something to worry about when we get closer to 65.

One elephant in the room that I haven’t mentioned are long term care costs. Those are non-medical costs related to help you perform everyday life tasks that you can’t do on your own. That’s a risk in retirement that can be handled in many ways so we’ll cover that topic on it’s own at another time.

One other thing is that there are FAR cheaper options for quality healthcare outside of the US. If you’re concerned about these costs and not tied to living in the US then that could be an option for you.

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What’s your HSA plan? Do you spend it or invest it? How does that fit into your retirement healthcare plan? Comment below, I’d love to hear from you.

Categories
Expenses Investing Saving Taxes

Health Savings Account (HSA): The Best Tax Advantaged Account

BLUF: The health savings account (HSA) is one of the best tax advantaged accounts that you can have. Use the tactics in this article to save big on taxes and create a money machine to fund retirement medical expenses.

Oh, it’s that time of year again. Benefits election time for all of us working those W2 jobs and for those using a variety of other healthcare sources. It felt like an appropriate time to talk about the amazing tax advantaged account that I and Mrs. MFI ignored for far too many years. I am talking about the Healthcare Savings Account (HSA)!

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Yeah, not the most exciting topic on the surface. You know what is exciting? Sticking it to the tax man and keeping more of your sweet sweet money. This account can also help you retire early and worry a bit less about long term care costs. Intrigued? Read on…

What am I going to cover? Three basic areas:

  1. HSA Overview – All the key foundational details about HSAs: What they are, who can open one, what you can buy with them and why they’re awesome.
  2. HSA Basic Tactics – What are some simple ways to take advantage of that account?
  3. HSA Advanced Tactics – Some much more creative ways that you can use this account to your advantage over the long term.

HSA Overview

If you already have knowledge of HSA’s feel free to skim through this next section. It’s dry, but necessary because it defines the rules around these accounts. The devil is in the details!

What Is An HSA?

Right from the IRS:

A Health Savings Account (HSA) is a tax-exempt trust or custodial account you set up with a qualified HSA trustee to pay or reimburse certain medical expenses you incur. You must be an eligible individual to qualify for an HSA.

No permission or authorization from the IRS is necessary to establish an HSA. You set up an HSA with a trustee. A qualified HSA trustee can be a bank, an insurance company, or anyone already approved by the IRS to be a trustee of individual retirement arrangements (IRAs) or Archer MSAs. The HSA can be established through a trustee that is different from your health plan provider.

https://www.irs.gov/publications/p969#en_US_2020_publink1000204023

Who Can Have An HSA?

Here are the requirements to qualify for an HSA:

  1. You are covered under a high deductible health plan (HDHP) on the first day of the month.
  2. You have no other health coverage except what is permitted (see the IRS here for details under Other Health)
  3. You aren’t enrolled in Medicare.
  4. You can’t be claimed as a dependent on someone else’s tax return from last year.

The key requirement for most is making sure that you have a HDHP. Not sure if you have one? Read here for how to tell.

Each person covered by an HDHP is allowed to have their own HSA account. Or, in a family situation, a single adult could have the family HSA and cover the expenses of the other spouse and dependents. There is no such thing as a “joint” HSA.

If you’re married and have a family plan then your spouse can have their own HSA if they’re covered by your family HDHP!

Quadruple Tax advantage

Why is this account awesome? So many tax advantages. HSA, oh how I love thee helping me stay tax free. Let me count the ways:

  1. Tax free going into your account if paid via a payroll deduction – No federal, state OR FICA taxes paid on the contributions.
  2. Reduces your taxable income – HSA contributions reduce your adjusted gross income (AGI) so you save taxes from your highest marginal tax bracket.
  3. Grows tax free – An HSA can be invested in stocks, bonds, ETFs and mutual funds and all growth is tax free. You can buy and sell within the account without any tax consequences.
  4. Tax free withdrawals for qualified medical expenses – As long as you use the HSA to pay for the IRS defined qualified medical expenses then the money comes out tax free as well.

An HSA is truly a special account.

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Who Can Use The HSA Funds?

More than you might realize. Qualified medical expenses are those incurred by the following persons.

  1. You and your spouse.
  2. All dependents you claim on your tax return.
  3. Any person you could have claimed as a dependent on your return except that:
    1. The person filed a joint return;
    2. The person had gross income of $4,300 or more; or
    3. You, or your spouse if filing jointly, could be claimed as a dependent on someone else’s 2020 return.

That means that even if you have partner #1 on a HDHP and partner #2 on a traditional HCP then you can use partner #1’s HSA for expenses incurred by partner #2.

Who Can Contribute To An HSA?

Anyone currently covered by a HDHP and has an open HSA can contribute money to it up to the annual limits.

How Much Can You Contribute?

The amount that you can contribute to an HSA varies each year so be sure to check to see what the latest limits are by searching for “IRS HSA contribution limits XXXX (year)”. The information in the tables below are for people that had plans for the entire year. Review the IRS website here for information on partial year contributions.

2021 HSA Limits Under Age 55 Age 55 or Older
Self Coverage$3,600$3,600 + $1,000 extra
Family$7,200$7,200 + $1,000 extra per spouse over 55
2022 HSA Limits Under Age 55 Age 55 or Older
Self Coverage$3,650$3,650 + $1,000 extra
Family$7,300$7,300 + $1,000 extra per spouse over 55

Unlike your 401k, employer contributions to your HSA DO count towards the annual max. For example, in 2021 if a single employee had an HSA and their employer contributed $1,000 to it then the employee could only contribute $2,600 more to hit the $3,600 annual max.

How Can HSA Funds Be Used?

What is reimbursable by an HSA? There are a LOT of things actually. Here is a selection of both common and unusual items that are covered:

  • Artificial Limbs
  • Birth Control Pills
  • Capital expenses to your home for medical care (widen doorways for a wheelchair, for example)
  • Dental Treatment
  • Eyeglasses
  • Fertility Enhancement
  • Guide dog or other service animal
  • Medicare Part B,D premiums
  • Menstruation Care Products
  • Nursing Services
  • Over the counter (OTC) drugs without the need for a prescription
  • Therapy
  • Transportation and Lodging to another place for the purpose of a medical procedure

Unfortunately, private health insurance premiums aren’t covered except in very narrow circumstances (COBRA). Sorry, no medical marijuana either.

Full list of qualified medical expenses here:

Be careful to not take unqualified distributions from the account before age 65. If you do those distributions are taxed as ordinary income AND subject to a 20% penalty. Ouch.

Do HSA Funds Ever Go Away?

No. To have and to hold, until death do you part. When you die your HSA will pass tax free to your spouse and they will enjoy the same tax free benefits. There are also

But what if I end up with more in my HSA account than I could possibly use? Easy, after age 65 you can withdraw money for non-healthcare expenses and it’s taxed as ordinary income.

HSA Tactics – Getting The Most Bang For Your Bucks

Now, lets talk about the fun topics. What are the different strategies that you can use to get the most of your HSA. I’ll present a variety of tactics and you can choose what best fits your situation.

I’m going to list these roughly in order from the more basic approaches and then heading to the more advanced and niche.

Use An HSA Debit Card To Pay For Expenses

Starting with the most basic approach. Save money in your HSA account in cash and whenever you have a qualifying healthcare expense, use your debit card to pay for it. The $4,928 listed below are all expenses that I paid directly from my HSA earlier in life.

It’s simple, convenient and is letting you use pre-tax dollars to pay for expenses that otherwise would be post tax. How much did that save me?

Well, our effective federal tax rate is about 15%. That means that we would have had to made about $5,800 in wages to pay for $4,928 in medical expenses net of taxes. $872 saved!

Investing With An HSA:

Saving money is great, but being FI minded we want our money to work for us. A beautiful thing about an HSA is that this isn’t just some crappy bank account where the money earns no interest. Oh no my friends, you can invest it!

You can connect the HSA to an investment account with firms like Fidelity (Mrs. MFI) or TD Ameritrade (Mr. MFI) and invest the money. It varies by HSA provider, but you generally need a minimum cash balance ($1,000 to $2,000) before they’ll allow you to start investing HSA money.

My HSA actually has two pieces: A cash account in a bank where all distributions are paid from and an investment account which are linked together but are operated by different companies. Mrs. MFI has a similar arrangement but with a different bank and investment company.

My work HSA is connected to TD Ameritrade and every paycheck it sweeps money to the TD Ameritrade invested HSA. I have the account setup to leave $1,000 (the minimum) in the HSA bank cash portion and sweep anything more into my HSA investment account.

Here are those auto sweep transactions happening every two weeks when I get paid.

That money can then be invested in whatever I choose on the platform. I’ve got the money invested in an ~80/20 split of VTI and BND. It’s a tax advantaged account so I can rebalance or change investments (sell) without any tax consequences.

Quarterly I’ll go in and make a purchase with the cash that’s accumulated. Looks like I’ve been slacking and have $1,280 accumulated that needs investing.

Clearly this year has been incredible unusual as far as US stock growth. YTD this basic invested HSA is up almost 50% or $6,000. Far more than I’m allowed to contribute to the account in a single year.

Vanguard for some reason has decided to stay out of this HSA market for the time being.

HSA Advanced Tactics

Now, for some fun stuff. How can you actually take the use of this fancy HSA to the next level and stack these benefits? Let’s explore that. I love nothing more than to find legitimate ways to game the system. Some of these ideas you can stack and use together.

Pay For Medical Expenses With A Cash Back Credit Card

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A key thing to understand about an HSA is that you can reimburse yourself tax free from that account, regardless of how you pay for the medical bill.

Knowing that, why would you ever use an HSA debit card to pay for a medical expense? I’m a huge fan of credit card rewards so I put as much as possible on my cards. I use the Citi DoubleCash credit card for 2% cash back on everything. If you spend $3,000 a year on medical bills that’s still $60 cash back for nothing.

Then you can submit to your HSA provider for reimbursement of that expense from your account. Here’s a key point. Your HSA provider isn’t necessarily going to check that what you’re submitting for is a legitimate expense. The IRS is the one that may come knocking and ask for proof that these were legitimate expenses.

For that reason, it’s important that you keep sufficient proof that the bill that was paid by your HSA was for a qualified medical expenses. Here’s what the IRS says you need to keep for records:

Source: https://www.irs.gov/publications/p969#en_US_2020_publink1000204088

How should you keep these records? I’m a big fan of Google Drive. I recommend keeping a copy of record which has the details of the service, proof that you paid the bill and when it was paid.

Use Medical Expenses To Hit A Credit Card Sign Up Bonus

If you’ve read the blog then you know I’m a fan of credit cards for travel rewards. A key part of travel rewards is to open a card with a great sign up bonus (SUB) that’s paid when you hit a minimum spending level.

No better way to hit a minimum spending level than to charge medical bills to a new credit card. Then you can use your HSA to pay yourself back. Medical bills are a pretty good candidate for this since there’s a big lag between the service and the bill arriving. Plenty of time to apply and get a new card. The bigger risk might actually be that they take TOO long to bill you.

One thing to be aware of is that if you pay a bill with a credit card then you give up your ability to negotiate down a larger bill. So, make sure that you do that first before paying the bill.

Take a medical tourism trip and partially reimburse yourself with your HSA.

This one seems like cheating but it’s in the rules. If you have a trip that you’re taking for medical tourism purposes then you can pay for transportation and some of your lodging with your HSA. By that I mean that you’re traveling to another location for the main purpose of having a medical procedure done.

Mexico is popular for very cheap dental care so if you had an expensive surgery this would be a great option. Take the trip, save a lot on the procedure, pay for it all on your favorite credit card. Then reimburse yourself for part of the trip and the surgery with your HSA. How sweet is that?

Source: IRS Publication 502 – Medical and Dental Expenses, Page 14

Pay For Medical Expenses Out Of Pocket, Let Your HSA Grow

Up until now we’ve been talking about paying for your medical expenses out of the HSA because it’s all tax free. The next idea might seem counter intuitive but you could pay for medical expenses out of pocket and NOT reimburse yourself from your HSA right away.

Why might you do that? The power of compounding. If you constantly spend the money that you contribute to the HSA then that money never gets a chance to compound. However, suppose that you let those HSA contributions grow to $50,000. By the 4% you could withdraw $2,000 a year and have a high likelihood of not running out of money over 30 years.

A Secret Emergency Fund

Here’s another trick. If you pay for medical expenses out of pocket you can reimburse yourself anytime in the future from your HSA. For example, I spent $3k this year on medical expenses (not my best year) but paid out of pocket.

I have those receipts and 10, 20 or 30 years from now I can use those receipts and pay myself back that $3k. It’s like having a special investment account that I can draw on anytime in the future when I need it. I love safety nets.

Long Term Care Self Insurance

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One concern of many is the cost of long term care in our later years. It’s understandable as nursing homes can cost $100,000+ a year.

What if you saved diligently, didn’t spend that HSA and then let compounding do it’s thing? Say that a couple is able to save $100,000 in an HSA by the time they’re 50 years old and never contribute another dime. They pay out of pocket for expenses to do that.

If that $100,000 grows by 7% annually then when they hit 80 years old the accounts will be have $811,000! That’s a healthy balance to handle your long term care.

What if you don’t need that much money? Well, after age 65 you can withdraw HSA money penalty free and it’s taxed as ordinary income. Problem solved. Did I mention that it’s not subject to required minimum distributions (RMDs) either?

Use It To Cover Insurance Premiums

Maybe you aren’t worried about long term care but you are worried about other medical expenses in retirement. You can’t use an HSA for private healthcare insurance but you CAN use it for Medicare part B and D insurance after age 65.

Below are insurance options that DO qualify for HSA reimbursement. As always, these change over time so consult the IRS website for the latest rules.

  1. Long-term care insurance.
  2. Health care continuation coverage (such as coverage under COBRA).
  3. Health care coverage while receiving unemployment compensation under federal or state law.
  4. Medicare and other health care coverage if you were 65 or older (other than premiums for a Medicare supplemental policy, such as Medigap).

Action Steps:

  • If you have a HDHP and don’t have an HSA, open one!
  • Setup your account to contribute to it every paycheck. Even if it’s $10 a paycheck, get started.
  • Look into how much you need in your HSA to start investing.
  • Once you have enough to start investing, open an HSA investment account. Fidelity is one of the top providers.
  • Setup your HSA to autosweep funds to your investment account.
  • If available, setup your investment account to auto-invest the proceeds.

Additional Resources:

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Categories
Expenses

Tracking Spending: A Foundational Skill of Personal Finance

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BLUF: A key foundational skill is knowing how to track your spending. Tracking spending brings awareness to where the money goes so you can cut out the waste. Understanding your annual spending is also necessary to know how much money you need in retirement.

Mrs. MFI and I used to watch a online personal finance show called Til Debt Do Us Part. A guilty pleasure that both helped scare us into being good with our money and also made us feel good that we weren’t in financial situations like these. It was about couples who were in serious debt usually through excessive spending on stuff. The format of the show always includes the participants estimating their monthly spending and current debt levels and then the host reveals what they’re really spending using their statements. Watch until the 7 minute mark and you’ll see an example of that part of the show.

One common theme across every episode of the show is that the participants don’t track their spending and have no idea how much they’re truly spending. This couple had no idea what their monthly spending was and they also under estimated their total debt by $33k!

Television shows like this obviously use the most extreme cases for shock and awe entertainment value but unfortunately this is a pretty common problem. A Mint.com survey in 2020 showed that 65% of people surveyed didn’t know how much they spent last month.

What is Tracking Spending?

The concept of tracking spending is not hard to understand as the name mostly gives it away. You keep track of every dollar that you spend so that you can see where the money goes. A common way would be to record each financial transaction and categorize that transaction.

An example of tracking transactions is shown below from a tool called You Need A Budget (YNAB) which I love and use daily. Each line is a transaction that is then assigned a category. The categories can be whatever you want them to be. They’re just buckets to let you track the different types of spending. This becomes important later when you want to see at a lower level where most of your money is going.

There are many tools available to help with tracking and multiple ways to track spending which we’ll dive into later.

Tracking Spending vs Budgeting

I think it’s an important time to point out that sometimes people talk about tracking spending and budgeting as if they are the same thing. They are NOT!

  • Tracking Spending – You spend money without any awareness of how much you could spend. You record the transactions and categorize them after the spending is done.
  • Budgeting – You have a plan for how your income will be spent before you actually spend the money. As life happens and money is spent you tweak your budget as needed on a month to month basis to try and keep the overall spending for the year to your plan. A deep dive into budgeting here.

Why is Tracking Spending Important?

There’s a reason that I called tracking spending a foundational skill in personal finance. It is so critically important that you understand where your money goes and unless you track it you really can’t know for sure. According to this Mint.com survey, 65% of Americans had no idea what they spent last month.

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People are also really bad at estimating since we’re filled with biases and optimism when it comes to our own actions. We never think we’re spending as much as we do so it’s critical to let the numbers do the talking. Otherwise we’re just guessing.

“What Gets Measured Gets Improved” – Peter Drucker

Peter Drucker said that famous quote many years. In business he was referring to the fact that if you track or measure something in business then you create awareness and you will improve what is being tracked.

Have you ever heard of a business that bought whatever it needed without tracking where the money was being spent on? Of course not unless it was an unsuccessful business. Why would you expect your household to be successful unless you track and understand where you are spending your money? When you track your person spending you create awareness of where the money is going and that will naturally lead to improvement.

At the end of 2018 I did my first annual summary of my spending for the year 2018. I didn’t track anything along the way but it was the first time even trying to see my overall spending and trying to categorize it. In 2019 I did the annual summary and bucketizing after the fact again but wasn’t yet looking for opportunities to reduce the spending significantly. It just seemed too painful to track every transaction.

In early 2020 I found FI and using 2019 data I started to making changes to reduce our spending. In December 2020 I went all in with YNAB tracking all expenses and truly budgeting for the first time. The results below speak for themselves. You can see what awareness of spending from tracking coupled with action can do for reducing your expenses. If you’re interested in the details of how I chopped down spending you can read about it here.

Beware of falling annual spending! 2019 included a $15,000 vacation instead of the normal $5,000 or the spending would have dropped every year.
I guess the pandemic in 2020 made us eat more?
I had an Amazon problem that I didn’t realize until I saw the data.

Spending is the Easiest to Control

woman wearing maroon velvet plunge neck long sleeved dress while carrying several paper bags photography
Photo by Andrea Piacquadio on Pexels.com

A simple formula for personal finance is savings = income – expenses. Most people they can’t make an instant change today and impact their income in a meaningful way tomorrow. As much as we’d love to give ourselves a raise when needed that’s rarely in our control. What we spend, however, is something that is in our control.

Tracking spending allows us to look at the areas where we might be wasting money and see what can be done to save money in those areas. Housing, transportation and food are the “big 3” expense categories for most people but all areas should be explored. Even saving $20 a week is still $1,000 a year.

FI Number Requires Annual Spending

This wouldn’t be an FI blog post without talking about the magic FI number which is based off 25 times your annual expenses (the 4% rule of thumb). What’s the only variable in that magical equation? Annual expenses? What does tracking spending tell you? Your annual expenses today.

Now, a true FI number is 25 * annual retirement expenses but until you get closer to FI enough to understand those retirement details you use your current annual expenses as your northern star.

The other magical thing to think about is your FI number in reverse. What do I mean by that? Since your annual expenses sets your FI number, ever dollar you reduce in annual spending saves $25 that you need in investible accounts. Every $1,000 in annual spending saved reduces your FI number by $25,000! How easy might it be to cut $20 a week in spending versus how hard is it to save $25,000?

For example, if my in 2018 cost $81,000. If that was my consistent spending then my FI number would be $81,000 * 25 = $2,025,000! Two million! My projected annual expenses for 2021 will be $52,000. Carried forward our FI number has dropped to $52,000*25 = $1,300,000. Wow. Making a number of life changes has dropped the amount we need to save by $725,000. That’s a lot of years of work time saved.

Laying the Budgeting Foundation

As previously mentioned, tracking expenses is not budgeting. However, it’s pretty hard to come up with a reasonable starting point for a budget unless you have general idea of how much money flows out of your wallet on average each month. Is $5,000 total a month reasonable? Is $500 a month reasonable to spend on food? $1,000? Your guess is as good as mine since everyone is different. Track spending first, then move onto budgeting.

How to Track Spending

Alright, enough already about why you probably should be tracking your spending and onto the real meat of the discussion. How do you actually track your spending?

Well, there are a variety of ways to track spending and you can choose the one that fits the amount of effort you want to spend, the level of detail you want and your personal lifestyle. I’ll go through a few common ones that I’ve used personally or have heard about others using.

For each method there are a variety of tools at your disposal to make the job easier. The good news? It’s never been easier to track your spending with so many great software tools that connect automatically with banks and credit cards.

Track At the Summary Level (Monthly / Yearly)

This is the “keep it simple” method to start. The goal here is to baby step you into the tracking spending without overwhelming you. After all, if you quit because it’s too much work then that’s not very helpful. If you’ve never tracked your spending before I’d recommend that you start here.

All we’re going to do is understand how much money you’ve spent on a monthly and yearly level using summaries from each account. You won’t necessarily understand how you’re spending the money yet, just how much. However, the hope here is that it’s easy and eye opening enough to make you want to dig for more answers.

  1. Make a list of all the ways that you spend money – Checking accounts and credit card that you use.
  2. Use online summary tools for each account to note how much you spent using that account or card last month.
  3. Add up the spending for each account. For bank accounts be careful to ignore transactions where money was just moved from one account to another. You may want to use a spreadsheet to keep track of the spending for each account for that month. After all, you’re going to keep doing this, right?
  4. Look at the data and see what it tells you. Are you spending more than you make? If you multiply that monthly amount by 12 how much would you spend a year? Unfortunately a single month will be a distorted view since everyone’s expenses has peaks and valleys.
  5. Continue this to see what you’ve spent for the last 6 months. That’s generally a much better way to get a monthly average.
  6. Jump back and pull the summary data from the previous full year and see what you spent last year. Credit cards often have online spending reports that can be pulled like the one from Citibank. The categories aren’t always the most useful but again the focus is the overall number. Does your annual spending surprise you compared with your annual take home pay?

Note: If your income is heavily cash based like a waitress or bartender and you don’t deposit that money directly into a bank account then it might be tricky to understand your spending in hindsight. If you don’t want to deposit the money then you’ll need to record each day how much cash income you’re making. That way you can check at month end how much cash you still have remaining on hand to determine what you’ve spent.

Track Every Transaction (What I use)

This is the most detailed method but with the tools available today it’s very easy to track and categorize each expense. It might take half a day or day to learn the tool and get it setup but after that it’s easy. As previously mentioned, I use YNAB and I probably spend 15 minutes a week dealing with transactions and categorizing them.

Choosing Categories

Using this method you’re going to keep track of every spending transaction and you’re going to put each transaction into a category or spending “bucket”. That way, you can measure each bucket at the end of every month or year and know what you’ve spent.

You have the flexibility to make as many or as few categories as you want. Just know that if you’ll have fewer categories you’ll have less granularity for your data in understand where the money is really going. For example, you could have the following categories as a very basic system:

  • Housing (Mortgage, Rent, Maintenance costs, related insurance)
  • Transportation (Car payments, car insurance, maintenance costs, gas, tolls, ride share)
  • Food (Groceries, eating out, alcohol, work lunches)
  • Everything else (Vacation, shopping, charity, personal care, entertainment, etc)

You could choose these 4 very high level categories of housing, transportation, food and everything else. It’s certainly better than nothing but it might not give you all the insights you want.

As you can see by the categories in parenthesis you can certainly break these high level categories down into many more categories. The key here is to just pick some categories and start tracking. There’s no perfect compliment and over time you’ll change what’s important for you to track.

What Categories I Use:

I use three high level groups for my categories called Core, Discretionary and Business expenses. Core expenses are everything I have to pay each month. If I lost my job I wouldn’t look at the core expenses for places to cut cost. That’s not to say that I couldn’t find something to cut, but I don’t plan financially on being able to cut here.

Discretionary expenses are the extra things in my life that I could partially or completely cut if I lost my job or something else bad happened. Now, this is a very individual choice for what goes in core versus discretionary. Don’t judge me for having charity in my discretionary expenses.

Why track core and discretionary expenses separately? Well it conveniently gives me the data that I need to calculate the size of my emergency fund.

Adding Transactions

This is very easy because I don’t have to do anything usually with YNAB. All of my accounts are in YNAB and linked to my financial institutions. Whenever there’s a new transaction to do something with a dot will appear next to the account name and those transactions are imported. The software makes a pretty good guess at the categories most of the time but if it doesn’t know it says “This needs a category”.

Bob Johnson Toyota in this case was getting my car serviced so I selected the Auto Maintenance category in my Core Expenses.

Seeing Where the Money Went

By tracking spending at the transaction level it becomes very clear to see month to month and year to date exactly where your money is going. For example here is my June spending on Core Expenses.

We adopted a dog in June and with all the accompanying medical care and “stuff” that comes with a new pooch that was a high spending month. Same with healthcare as I had a procedure and accompanying appointments. If we took these two areas and multiplied by 12 months we’d get $12k of pet expenses and $8k of healthcare! Ouch. But that’s not really the case because monthly spikes happen and they aren’t consistent. Let’s look for January through June of 2021 to get a better idea.

When you look at 6 months of data the averages become more normal. We lost our dog to cancer in March so there were still a lot unusually high pet expense months but it’s $3k for the first half of the year. Barring anything catastrophic happening we’ll be able to keep things within the $3,500 pet expense budget for the year.

A similar story for healthcare. June was heavy but only $732 was spent from Jan-June or $106/mo.

Other Tools

I’m partial to YNAB because it’s just worked very well and I also use it for budgeting. But it does cost $84/year and while I think I more than save that much by using it in money and time that’s a turn off for some people.

  • Mint.com – Now owned by Intuit, the same company as TurboTax is a free tool for tracking expenses. It can also link to online accounts and import transactions. I tried it years ago and was frustrated in not getting my transactions and balances to match up. I know plenty of others that use it successfully though.
  • Spreadsheet – Old school but it works. It is a lot more work to do everything from manually entering transactions to summarizing the data but it is an option.
  • Paper – Even more old school with all the downsides of a spreadsheet plus you’ll have to manually calculate spending and averages.
  • Other – There are many other tools out there. Some are called “budgeting” apps but I’m not sure how well they do in that regard. I’ll let you read reviews and decide for yourself.

Other Benefits of Tracking Spending

There are a couple of side benefits worth noting by tracking spending in a detailed way.

  1. More conscious spender – When you see real time how much money is going out the door it makes you more hyper aware of your spending. That in turn makes me think about purchases more carefully before I made them.
  2. Awareness of fraud – By seeing every transaction that hits your accounts on a daily basis you will spot unusual transactions right away.
  3. Easy to see all transactions – Instead of logging into each online account the data is all there right on one dashboard. I don’t have to go hunting down data figuring out which card and which month I spent something.
  4. Peace of Mind – I’ve found that I have more peace of mind when I feel like I have the full spending picture.

Action Steps:

  • If you want to tiptoe in tracking spending:
    • Make a list of all your spending accounts and then look up what you spent last month using online summaries. How does that compare with what you thought? To your income?
    • Repeat that for the last 6 months. If you really want to dig in look up summary spending for the previous year.
  • If you want to jump all in:
    • Research the tracking tools like YNAB, Mint.com or others and pick one. I’m partial to YNAB which does have a free 35 day trial. If you use my referral link we each get a an extra free month of YNAB.
    • Make a list of categories to track. DON’T get paralyzed here! Take a stab at it thinking through your spending and run with it.
    • Track! Things will be slow at first with any tool but you’ll get faster and more efficient.
    • Don’t sweat the small stuff – some people obsess over where every penny goes. Don’t stress over every dollar. We’re looking to find and fix big spending issues, not little ones.
  • Move on to budgeting!

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Categories
Expenses Travel

Travel Rewards Basics: Saving Money on Travel

person with toy airplane on world map
Photo by Andrea Piacquadio on Pexels.com

BLUF: Travels rewards are an effective way to greatly reduce the cost of traveling by minimizing or eliminating your airline and hotel costs. It lets you keep experiencing the world while not blowing your budget!

Who doesn’t love to travel? See different fascinating places, experience different cultures, visit different famous places and oh my, the food. The problem, is the cost of all that fun. Being that this is an FI focused blog, controlling expenses is important as that helps us reach our goal faster. I’m willing to spend the money on vacations, but I’m all for paying less for the same experiences. What’s not to like about that?

What are Travel Rewards?

Travel rewards, also referred to sometimes as either travel hacking or credit card hacking. The concept goes by a variety of different names but they generally mean the same thing. We’re trying to use credit cards to reduce or eliminate travel expenses. These usually revolves around the two largest expenses in a trip which are transportation (airline fares) and lodging (hotel costs).

How? You use normal life spending (groceries, gas, restaurants…etc) put on a rewards credit card to accumulate points. Those points can then be used to book airfare, hotels and rental cars outright or can be used to reduce the cost of them.

For example, say that a couple lived in Atlanta and wanted to take a trip to Hawaii. Atlanta is a hub for Delta so you look online. The cheapest option in late May would be $1,461.22 for two people. Most people would just chalk that up to the normal price of travel, pay and move in. Maybe they would charge it to a 2% cash back card and get $30 back for the purchase.

Example of a typical trip from Atlanta to Hawaii using cash.

Wouldn’t it be nice if you didn’t have to pay for that airfare? On the Delta website you can very easily flip from paying in cash to miles. Picking the exact same flights I see that it costs 70,000 miles and $22.40 to book using miles. Okay, now to get 70,000 miles.

Same trip from Atlanta to Hawaii using miles.

Right on Deltas website there’s a section for credit cards tied to SkyMiles which is Delta’s mileage program.

Boom! Right on the page there’s an American Express card that conveniently has a 70,000 mile bonus right now with no annual fee for the first year. The only stipulation is that you spend $2,000 in the first 3 months. Spending $670/mo should be problem for anyone with the life expenses that you can charge to a credit card.

Just like that we flew to Hawaii round trip spending $22.41 for two people instead of $1,461.

Types of Travel Rewards Programs

There are three main groups of travel rewards credit cards out there. Let’s dive into the details of each.

Flexible Points Programs

Flexible points programs give you rewards in points associated with their respective programs. Then, depending on the program you can either book travel directly with the company using their travel portal, transfer points to airline or hotel partners in their rewards point system or redeem the points for cash. The best deals are usually via points transfers but your mileage may vary (pun intended 😃).

One great thing about these programs is that the points usually don’t expire. As long as you maintain an account in good standing with them (at least one card) then they just sit there.

  • Chase Ultimate Rewards (UR) Points – This is one of the most popular programs due to the high value of their points, large number of card options and large number of transfer partners. You can buy travel directly through their website, transfer points to travel partners in their rewards programs or take the points as cash.
  • American Express Membership Rewards (MR) Points – Also very popular and some people prefer it over Chase. It has different transfer partners than Chase. You can buy travel directly through their website, transfer points to travel partners in their rewards programs or take the points as cash.
  • Citibank ThankYou Points – A newer player to the flexible points programs game these aren’t as publicized but they work in a similar way. Just like Chase and American Express they let you book travel directly through a portal with them, transfer them to partners or redeem them for cash.
  • Capital One “Miles” – Capital One calls its system miles but it’s really a flexible points system like the others. In general it’s the least valuable because it has the fewest transfer partners, which is where you get the most value from your miles. It does have one unique feature in that you can use your miles to wipe out any travel expense that you pay for in cash at $0.01 per mile. For example, you could use 50,000 “miles” to wipe out a $500 rental car charge on your Capital One card. This is one way to get reimbursed for other travel expenses that you otherwise might have trouble getting for free.

Note that while these programs are very flexible, they don’t transfer to ALL airlines and hotels out there. For example, Chase UR points don’t transfer directly to Delta at the time of writing this article (see image below). You can use the points to book Delta through their portal. American Express DOES transfer to Delta. It’s best to go into accumulating points in these programs with a next trip in mind so that your spending gets you points that you know you will use.

Chase UR Airline Partners in April 2021

Airline Miles Programs

Each airline has their own mileage programs and they partner with different credit card companies to offer credit cards that accumulate miles in those awards programs. Spending money with those cards accumulates miles and the sign up bonus (SUB) is also paid out in those miles.

For example, here are a couple different Chase cards associated with different airlines. The United card would give you Explorer miles and the British Airways card would give you Avios points. When you open these cards they connect with an existing rewards account with the airline or open a new one if you didn’t already have one.

Your points are automatically transferred over to the airline account (often monthly) so your points are safe even if you cancel the credit card. Each airline has it’s own rules for points expiration though so be sure to look that up so your points don’t accidentally expire on you.

Hotel Points Programs

Hotel rewards cards work in the same way as airline cards. The biggest difference is that the value of each point can vary much more wildly between programs compared with the airlines.

Sub-optimal way to accumulate travel rewards

If I were to describe the perfect customer in the eyes of a credit card
company it would probably go something like this. A customer is lured into signing up for a card with a substantial SUB, but doesn’t hit the minimum spend to get the bonus. They keep the card their whole life and carry an account balance the entire time.

I know my readers are smarter than that and would never do those things. However, many customers do get a SUB and then just keep a credit card forever. They enjoyed that bonus and built loyalty over the year they have it and often keep the card. That’s exactly what the credit card companies are hoping you do.

What’s the problem with that? It will take you forever to accumulate travel rewards after the SUB. In the previous Delta example we spent $2,000 in 3 months and flew to Hawaii for free. After that though, you accumulate 2x miles on dining and 2x miles on groceries. If I spend $800/month on groceries and $200/month on dining that’s $12,000 or 24,000 miles a year. It would take me 3 years to earn enough miles to go back to Hawaii! 3 months vs. 3 years. That’s the power of the SUB!

Supercharged travel rewards

What’s the optimal way to accumulate travel rewards then? Maximize the SUB of course. Open a credit card, spend enough to hit the SUB and then move on to another card. How effective is this? Very. In the last 18 months my Mrs. MFI and I have 308,000 UR points, 115,000 United miles and 61,000 American Airline miles. This is all using personal spending in a household of two people that spends less than $60k a year.

…But it will destroy my credit!

One of the most common misconceptions is that travel rewards (also sometimes card credit card churning) will destroy your credit score. Surely opening and closing that many accounts must hurt your score? Nope. This might be obvious to you if you read my article on how credit scores work and how to increase yours.

Yes, you take a small temporary hit when accounts are opened but the number of open accounts is a low contributor to your credit score. Payment history and credit utilization are high contributors to your credit score and both are improved with more cards open. Obviously this assumes on time payments and not carrying a balance. Opening 4 personal credit cards in the last 18 months still has my scores in the 800s.

My credit scores are doing just fine…

People that should and should NOT try travel rewards:

Just like casino’s being built on the money from the losing gamblers, credit card companies profit from the people that aren’t responsible with their credit. The people that use travel rewards successfully are losing credit card companies money but those people are the minority of credit users. If you are going to truly use travel rewards to save money then you MUST be a responsible credit card user.

People that should try travel rewards:

  • Have good credit scores of at least 700. All the best rewards cards require excellent credit.
  • Pay off their credit cards in full each month (they never pay interest charges).
  • Know how to control their spending and can hit the minimum.

Travel Rewards Essential Tips:

  • Plan our your trips far in advance. It takes time to open cards, hit the spend limits and get awarded mileage. Also, the best deals get booked up early so you can’t usually get good points deals last minute unless demand is low.
  • Target cards and points to a trip, not just randomly based on the best SUB. It’s alluring to stockpile points but what good is that if you have trouble using them? Best to pick a trip then focus on how to get airfare and hotels on that trip for free.
  • Never sign up for a card until you have a plan to hit the SUB spending requirement using your normal life expenses. If you’re spending money that you otherwise wouldn’t to hit a SUB, are you really saving money? This sometimes means opening cards around major purchases or expensive yearly costs like insurance premiums and taxes.
  • Don’t sign up for a new card within a month of the last card. This can be a red flag and could get you denied.
  • Play the game with two players. If you have a spouse, have both people sign up for cards. This allows you to do cool things like sign up for a card and then refer your partner getting you each a bonus.
  • Keep all cards open for at least a year and never cancel right after hitting the SUB. This can trigger that you’re abusing the system and set off red flags. When you’ve had a card for a year the annual fee will hit again. At this point you can close the card and they will credit back the annual fee.

Action Steps:

  1. Figure out the next trip that you want to take that requires flying.
  2. See what it would cost you to take that trip paying for it with cash. Then see how many miles it would take you to book the same trip.
  3. Look at the airline credit cards available and see if there’s a card that can get you the points that you need. This might be only one card or could require two different cards. Besides airlines there are lots of sites like Nerdwallet and The Points Guy with up to date info on the cards with the best rewards.
  4. Sign up, hit the minimum spend, get the SUB and book those flights for free!

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Categories
Expenses General FI

Credit Scores: How they work and how to increase yours

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Photo by Andrea Piacquadio on Pexels.com

BLUF: Your credit score can have a substantial financial impact on your life. Many people don’t understand them, pay attention to them or put in the work this one thing that can save them or cost them a lot of money. Putting in the work to increase your credit score can save you a lot of money over a lifetime.

Note: Some links include affiliate referrals and the blog will receive a benefit if you sign up for a service using that link.

What is credit?

Credit is the ability to borrow money or access goods or services with the understanding that you’ll pay later. The creditor is the person or business extending credit to you with the expectation that you pay them back the full amount at a later date including interest. Some common borrowing examples include:

  • Store cards (Target)
  • Credit cards
  • Car loan
  • Mortgage loan (home)
  • Personal loan
  • Boat / Motorcycle / ATV loan

What is a credit report?

To calculate a credit score, though, you need data. That’s where the three main credit bureaus: Equifax, Experian and Transunion come in. These companies each collect information on all the credit related activity that you have from each lender and compile that data into a credit report. This includes information like account type, payment history, loan balances and available credit.

When you use a credit report service on the internet it’s pulling a credit report from one or multiple of the credit bureaus. All of the information reported to them in that credit report then is used with FICO’s formulas to calculate a credit score.

What is a credit score?

Have you ever loaned a friend money and they didn’t pay you back? Not fun. Creditors that loan money as their business certainly don’t like it either. They needed a way to understand the likelihood that a person will pay back borrowed money so that they could decide whether or not to loan them money. The two main pieces of data used by creditors to extend credit are your income and your credit score.

A credit score is a numerical way to summarize your personal credit risk based on your credit data. The FICO score, originally developed by Fair, Isaac and COmpany in the 1950’s has become the most widely used method for calculating a credit score. FICO scores generally range from 300-850 although some industry specific scores do go up to 900. It isn’t a static formula though as they keep tweaking it and evolving it based on lender needs and consumer behavior.

[1] Credit: https://www.ficoscore.com/faq

There is a second type of credit score that exists called the VantageScore that was created in 2006 by the three credit bureaus. The VantageScore 3.0 is very similiar to the FICOScore in that it ranges from 300-850. It uses 6 categories that are similar to the FICOScore 5 categories below but are slightly different in percentage weighting.[12]

In this article I will largely talk to the details of your FICO score although I’ve used some additional screenshots and data from CreditKarma which is using the VantageScore 3.0. The tips and advice for how these scores impact your life and how to improve them still hold regardless of which score is used. If you’d like to read more about the differences between the FICOScore and VantageScore systems you can do so here.

What makes up your credit score?

The exact formula of how a credit score is calculated isn’t public information but what is known are the factors that make up your credit score. I’ll go into the factors in detail using information from FICOscore.com (FICO), myFICO.com (FICO) and CreditKarma.com (Vantage). These factors apply to all credit accounts on your credit report.

[2] https://www.ficoscore.com/education#CreditDecisions

Payment History (35% of the credit score)

Payment history is whether you make payments on time or late each month. The lateness of the payment matters as well and are bucketized as either 30, 60 or 90 days late with each step being a bigger hit to your score. Typically after 90 days late the next step is going to collections where it becomes a derogatory mark.

How much could it impact your score being late? “With a FICO® Score of 780 (on a scale of 300-850), being just 30 days late on a payment could drop your score to between 670 and 690, according to FICO. If your score was 680, having a payment reported as 30 days late could drop your score to between 600 and 620 according to FICO.” [3] Ouch!

CreditKarma.com shows this view as a percentage of on time payments. If you had a single credit card for 10 years then you’d have 120 payments. If you had just 2 late payments in that time then (120-2) / 120 = 98.3% on time payments which is already in the yellow. It doesn’t take much to impact your score so it’s best to avoid any late payments.

CreditKarma.com view of my VantageScore 3.0 payment history

Derogatory marks such as a bill that goes to collections, a bankruptcy, tax lien and civil judgements. Even a single derogatory mark is high impact and the worst part is that they can stay on your credit report for 7-10 years!

If you thought late payments had a negative impact on your score, hang onto your hat for the impact of a bankruptcy. “Bankruptcy could have an even bigger impact, according to FICO, potentially dropping a FICO® Score of 780 to between 540 and 560, while a 680 score could fall to between 530 and 550.” [3]

It is important to note that a late payment or a derogatory mark does negatively impact your score immediately, but that score impact starts to fade over time if you don’t have any other bad marks.

CreditKarma VantagScore 3.0 view of my derogatory marks

Amounts Owed (30% of the credit score)

There are 5 different factors that FICO uses in the amounts owed category that feed into the 30% weighting:

  1. The amount owed on all accounts – Even if you pay off your cards in full you’ll almost always show as having a balance on your credit report. This is just the timing of when the balance is reported compared with your payoff date.
  2. The amount owed on different account types – The type of account like an installment loan for a car is viewed differently than a revolving credit account like a credit card.
  3. How many of your accounts have balances – If all of your cards have a balance you appear to be higher risk than a borrower with mostly zero balances.
  4. How much is owed on an installment loan compared with the original loan – If you take a $200,000 mortgage your credit score will improve as you go from a balance of $200,000 (100%) to $160,000 (80%)
  5. Credit card usage ratio – This is the total balances / total available credit. Just like with #1 your credit report likely won’t show a zero balance even if you pay off your cards in full because of the timing of reporting the balances. Example – if you owe $500 on a $2,000 limit card and $1,000 on a $15,000 limit card then your usage would be $1,500 / $17,000 or 8.8%. [4]
CreditKarma VantageScore 3.0 card usage view.

Length of Credit History (15% of the credit score)

The length of your credit history deals with the age of the credit accounts on your credit report. Very logically, the longer you’ve had lines of credit and shown responsible use of them, the lower the risk you are to a lender. There are three things that the FICO score takes into account in this category:

  1. How long your credit accounts have been open including the age of your oldest account, the age of your newest account, and an average age of all your accounts.
  2. How long specific credit accounts have been open.
  3. How long it has been since the account has been used.[5]

CreditKarma shows you information on the average age of open accounts which is doing just that – averaging the time each account has been open across all of your open accounts. 7-8 years on average is the start of the good area for a VantageScore 3.0 so as you can see this kind of thing takes time. This is one reason why it’s bad to close old accounts if you aren’t using them. It could substantially drop the average age of your credit.

Snapshot at CreditKarma VantageScore 3.0 showing how long accounts have been open.

New Credit (10% of the credit score)

When you attempt to open up a line of credit there is what’s known as a hard inquiry to your credit report. These hard inquiries stay on your report for two years although only one year is used to calculate your FICO score.[6] There are three main items that FICO looks at in the new credit category:

  1. The number of new accounts that you have.
  2. How many recent inquiries you have – this is anytime that a lender requests your credit score or report. When this is done to open an account it’s known as a hard inquiry and is more impactful on your credit score. A soft inquiry on the other hand does not impact your credit score. Soft inquiries include things like checking your credit score personally, getting a copy of your credit report and getting pre-approval from a lender for credit.[7]
  3. The time since opening up your last new account – borrowers who open many new accounts in a short period of time are higher risk.[6]
Accounts opened within the last two years show on your report.

Hard inquires stay on your credit report for a little more than two years. Their impact on your score is still minor and that impact also decreases over time.[7]

Hard inquiry view from CreditKarma VantageScore 3.0.

Credit Mix (10% of the credit score)

Credit mix refers to the different types of credit accounts that you may have on your account. There are two main types of accounts:

  1. Revolving credit accounts – these are accounts with an established credit limit that you can reuse and make payments on. Examples include credit cards, retail store cards, gas station cards and even a home equity line of credit (HELOC).
  2. Installment loan – a fixed balance is paid off progressively over time. Examples include a car loan, mortgage loan, student loan, furniture loan, boat loan and motorcycle loan.

I wouldn’t create new loans just to satisfy the mix the accounts here being that it’s only worth 10%. To me this is just something to be aware of as a low credit impact.

What credit score is good?

That’s how credit scores work, but what is a good credit score? The table below is a good general guideline for what each score means for a FICOScore.

[11] FICOScore.com breakdown of what each score range means.

To qualify for the best credit card offers you often need at least 690. In the mortgage example down the article the top rate is achieved at a 760 FICO score. Once you’re in the upper 700’s you can feel pretty confident that your score is good enough to get the best rate.

How a credit score impacts your life:

Okay, enough going on and on about how credit scores work. Why should I care? How does this impact my life? Well, your credit score follows you forever and is used in an increasing number of ways because it’s an easy assessment of risk based on your consumer behaviors. Here are examples of life situations when your credit score and/or report are used:

  • To qualify for a loan – Fairly obvious but your credit score is a big part of being approved or denied for a loan. Each lender has their own standards for risk and if your score is too low many lenders will deny you.
  • To determine the interest rate offered on any loan – if you are approved for a loan, the rate that you pay is HIGHLY dependent on your credit score. See the mortgage example in the next section. This translates into a low credit score costing you a lot of money over the course of your life.
  • To get approved for the most lucrative credit cards – who doesn’t love cash back and travel rewards? Unfortunately only high credit scores are eligible for the best cards. If you don’t have at least a 700 score you can’t get the best cards.
  • To rent a place to live – Landlords sometimes check your credit. A landlord isn’t extending credit but they do need to be paid monthly just like an installment loan. They want low risk tenants that will pay reliably. They may not rent to you or ask for a larger security deposit. Foreclosures and evictions show up on a credit report which could be grounds to deny your application.
  • To get insurance – insurance premiums are payments and insurance companies they want their money. You could receive higher rates or be denied if you credit report shows a poor payment history.
  • To get a new job – they need written permission but prospective employers can request a copy of your credit report. Some jobs require the use of company credit cards and they want to ensure that the applicant will be able to both get approved for a credit card if needed and is also trustworthy in their use of that card.
  • To get utilities setup – yet another payment that a utility company wants made. You could be forced to provide a security deposit if you have bad credit.[9]

Credit score impact on a mortgage

Here’s a great example of why you should care about your credit score. Even if you came from the Dave Ramsey camp and don’t believe in credit cards, chances are you’ll have a mortgage at some point in your life. In the example below the different between a 760 credit score and a 639 credit score is $166/mo and $63,472 more paid in interest over the life of the loan! You pay $63,472 extra and get absolutely nothing in return. It’s purely a tax on a higher risk borrower because you’re more likely to default based on your credit score. [10]

Not maintaining top credit can cost you, a lot!

Tips for increasing your credit score:

  • Improving Length of Credit History: Stop closing accounts! This may seem counter intuitive but it can actually damage your credit score to close old accounts. Why? The length of your credit history will decrease if you close a very old account. Even if you don’t use a card anymore keep it open and put one or two charges a year on it to ensure the lender doesn’t close the account for inactivity. If the card has an annual fee see if you can do a product change.
  • Improving Payment History: Did you know that you don’t need to have a payment due to register an on-time payment with the credit bureau? The screenshot below is the payment history for a credit card that I use once a year to keep it active.
  • Improving Length of Credit History & Payment History: Add overdraft protection to your checking account. My overdraft protection shows up as a loan on my credit history. It’s the oldest thing on my credit report! That’s an easy way to build credit.
  • Improving Payment History: Make your payments FAR in advance of the bill. Why screw around waiting until the last minute and risk a problem that could give you a late payment? I pay my credit card balances in full every two weeks on the day that I get paid. Just because the credit card company gives you an extra month doesn’t mean you have to wait until a statement is issued to pay your card.
Paying those credit cards like clockwork, every two weeks.
  • Improving Payment History: Turn on autopay for your credit cards for the minimum payment due as a backup. Then you know you’ll never be late. You can still pay your cards on whatever schedule you want manually. I have autopay turned on even though I pay my cards every two weeks. Screenshot below showing the wide variety of autopay options.
  • Improve payment history: Have a system to ensure you never miss a payment. Create a payment schedule for bills so you know what bill is due on what day. I do this in YNAB by writing the due date next to each bill.

Improve Amounts Owed: This seems counter intuitive but open up another credit card. If you have a $3,000 balance on a $5,000 limit then you’re using 60% of your available credit. If you open another $5,000 limit card then your usage drops to 30% instantly. This is why credit card rewards can actually increase your credit score. Amount owed has a 30% impact on your credit score while new accounts have a 10% impact. The positive impact of reducing amounts owed with a new card outweighs the the temporary hit of a hard credit inquiry.

  • Improve Payment History: Open additional credit card accounts to reduce the impact of a late payment. More accounts = more payments which will more quickly lessen the impact of a missed payment. If you have a single card with 1 late payment in 1 year you have 11/12 or 92% on time payments. If you keep that same card for another year you have 23/24 on time payments or 96%. Still in the red. However, if you opened a second card for year 2 then you’d have 35/36 or 97% on time payments. If you opened a second and third card in year 2 you’d have 47/48 or 98% on time payments. You recover faster.
  • Figure out the ideal credit score range to be approved for credit before applying. Hard inquiries ding your credit score so do you homework first. For example, Nerdwallet.com gives you a recommended credit score range in order to be approved for a card.
Nerdwallet.com example credit card information.

Tips for establishing credit from scratch:

How do you build credit when nobody will extend you credit…because you have no credit history? It’s a cruel catch-22 situation. Here are some ideas to build a credit history if you’re just starting out:

  • Apply for an overdraft line of credit on your local bank checking account. This establishes a long term loan and if you have a savings account with cash in it this is low risk to the lender. Ask far a small amount as any amount will build credit.
  • Ask to be an authorized user on a relative or friends credit card. Even if they never hand you the physical credit card it’s still building your credit. That would be one way to make their risk zero (you don’t have a card to charge their account) and it’s still building your credit.
  • Get a secured credit card. These are credit cards where you put up cash as collateral. For example, they’ll make you provide $500 if your credit limit is $500 to ensure there’s no risk to the lender.

Action Steps:

  • Get a free copy of your credit report and credit score from a site like CreditKarma.com.
  • Review your credit report closely. Does anything look wrong?
  • If you have any errors contact the credit bureau (Transunion, Equifax, etc) and request that it’s fixed.
  • Take action from the tips section!
  • Take advantage if you have great credit with credit card rewards. I save $265/yr buying groceries with a card that requires excellent credit.
  • If you’ve increased your credit score drastically since opening up lines of credit call and ask them to reduce your APR. Refinance installment loans to lower rates.

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How have you improved your credit score? Did you learn something new? Did you take action and improve your score? Comment below!

Article Sources:

  1. FICOScore. Do I have more than one FICO score? https://www.ficoscore.com/faq. Accessed March 27th, 2021.
  2. FICOScore. YOUR CREDIT DECISIONS HAVE A DIRECT IMPACT ON YOUR SCORES https://www.ficoscore.com/education#CreditDecisions. Accessed March 27th, 2021.
  3. CreditKarma. Payment history: What it is, and why it matters to your credit. https://www.creditkarma.com/advice/i/payment-history-credit-report. Accessed March 27th, 2021.
  4. myFICO. What is Amounts Owed? https://www.myfico.com/credit-education/credit-scores/amount-of-debt. Accessed March 28th, 2021.
  5. myFICO. What is the Length of Your Credit History? https://www.myfico.com/credit-education/credit-scores/length-of-credit-history. Accessed March 28th, 2021.
  6. myFICO. What is New Credit? https://www.myfico.com/credit-education/credit-scores/new-credit. Accessed March 28th, 2021.
  7. Experian. Hard vs. Soft Inquiries on Your Credit Report. https://www.experian.com/blogs/ask-experian/credit-education/report-basics/hard-vs-soft-inquiries-on-your-credit-report/ Accessed March 28th, 2021.
  8. myFICO. What Does Credit Mix Mean? https://www.myfico.com/credit-education/credit-scores/credit-mix. Accessed March 28th, 2021.
  9. thebalance. People Who Check Your Credit https://www.thebalance.com/people-who-check-credit-report-960517. Accessed March 28th, 2021.
  10. myFICO Loan Savings Calculator. https://www.myfico.com/credit-education/calculators/loan-savings-calculator/ Accessed March 28th, 2021.
  11. FICOScore. What is a good FICO Score? https://www.ficoscore.com/faq. Accessed March 28th, 2021.
  12. VantageScore. VantageScore 3.0 White Paper. https://vantagescore.com/pdfs/VantageScore3-0_WhitePaper.pdf. Accessed March 29th, 2021
Categories
Expenses

Reduce car insurance : How I saved 44% in 4 months.

BLUF: You can reduce car insurance expenses by reviewing your policy, taking advantage of all savings options, eliminating benefits that you don’t care about and running the math before dismissing options as too “risky”.

Reducing expenses isn’t very sexy. Reducing your car insurance premiums is probably even less so. It’s not like getting a large change in income from a bonus, large pay raise, inheritance or winning the lotto. As I write this, someone is about to have their world turned upside down by winning $1B(!) with mega millions.

However, reducing expenses where you see no value is important. Reducing expenses also doesn’t happen by accident. You don’t wake up on January 1st and realize “damn, I spent $10k less last year!” It requires conscious decisions and the first thing required is to track your spending so you can see where the money goes.

After I reviewed my spending from last year I set a goal to spend less than $55,000 this year. But there’s a catch. I don’t want that reduction in spending to reduce my happiness. If I’m reducing my happiness then I’m sacrificing a long term goal of living a happy life for a short term goal of spending less than $55,000. Which do you think is more important?

How do you reduce spending without reducing happiness? Focus on optimizing your spending around the areas where you just care about functionality. In this example, car insurance. If you have a car, you need car insurance. But aside from having enough insurance to protect your from liability and fix your car in a wreck, do you want to spend anymore money than necessary?

It’s with that thought in mind that I chose to focus on car insurance as one area to try and cut costs over the last year. The list below is actually for a 6 month premium period so the cost is $2,115 for the year. Yikes! I don’t know about you but I sure as hell can think of better ways to spend that kind of money every year. So that’s our starting point. Lets talk about how I was able to reduce that number.

March 2020 Auto Insurance costs (6 months) via Allstate

Reduce car insurance expenses

Here is how I was able to reduce my premiums.

Sold the Corvette – Saved $654/year

You’re probably thinking I’m so full of shit right now. How on earth is selling a sports car that I loved not reducing my happiness? Well, like many Facebook relationship statuses, it’s complicated.

It was a beautiful car with a sweet sounding exhaust making it quite the attention getter. I felt proud to own it and it always felt nice when the car would get compliments. At 430hp it was a rocket ship and I’m still baffled as to how I escaped a speeding ticket in it.

There’s a lot of baggage that came with it though. Mrs. MFI actually didn’t like to ride in it because it was too flashy for her tastes so we didn’t use it at every opportunity. There’s parking far out to prevent door dings and the constant worry about theft and vandalism in public. I thought a front license plate looked stupid on it so I risked a ticket every time I drove it since it’s required in NY and I left it off. The car is so low to the ground that I have to even angle in and out of my own driveway to not scrape the front. You have to “fall” in and out of it as well.

Having a second car creates double the work in dealing with it. A second regististration to get. A second state inspection to get done. More oil changes to get done and of course any repairs on top of that. Did I mention that reasonably priced tires for it were $1,200 a set? I’m fortunate to have a large garage to save on winter storage but it still required work to put it to sleep and then play a game of car Tetris. I know, I know: first world problems. But, it’s still something that I don’t enjoy doing that takes my time and energy every year.

Throw in a pandemic where I was driving substantially less and that was the final straw.

Car Tetris – played every winter in New York

Added DriveWise – Saved $61/year

This is an Allstate OBD-2 device that records your driving data and gives you savings off your insurance based on your driving habits. You get a percentage off your insurance if you drive during safe hours of the day, drive under 80mph and avoid hard braking. How well you do each of those determines how much you save. Mrs. MFI was worried about privacy but I reminded her that our Google home, Alexa and iPhone are already listening to her.

Reduced auto policy coverage to align with my umbrella policy – Saved $24/year

What is an umbrella insurance policy? Umbrella insurance is a broad, catch all insurance policy that kicks in when your other insurance runs out. In this sue-happy world it’s an extra layer of protection between you and financial ruin if little Johnny’s backyard trampoline party results in a serious hurt child. Or if you’re unlucky enough to cause a 5 car pile up on the ride home.

More about umbrella policies here.

Umbrella insurance helped save me money.
Photo by Pixabay on Pexels.com

It turns out that although boring, there’s insight to be gained in reviewing your policy details. Umbrella policies have required underlying insurance limits. For an umbrella policy to kick in and help you are required to keep certain insurance coverage in a separate policy. In the example below, an auto policy with bodily injury coverage of $250,000 each person, $500,000 each occurrence (accident) are required.

Minimum coverage required by my umbrella policy

I was originally paying for $500,000 per person (pp), $1,000,000 each occurrence (eo) in my auto policy and lowered that to match the umbrella minimum requirements at $250k/$500k. I still have great coverage, I just lose a little bit of maximum coverage.

Coverage comparison before and after including umbrella insurance.
Coverage comparison before and after.

The umbrella policy kicks in after the auto policy limits are reached to add an additional $1,000,000 per accident in the case of a $2M policy. It doesn’t care how you split that among individual people.

No, that isn’t a typo. A $2M policy doesn’t give $2M per accident (occurrence), it gives you $2M per year (policy period) in the case of bodily injury and property damage liability. Read and understand your coverage!

Raised deductibles – Saved $192/year

This one might be a bit controversial but I’ll let the math do the talking. I changed our deductibles from $500 to $2,000 for both comprehensive and collision. $2,000 is a big number and many people are scared off before even talking through what that means. Is it more beneficial to take an additional $1,500 in risk? Let’s find out.

Insurance is important because random things can happen and the cost to replace a car or coverage someone’s hospital bills is far more than the cost of insurance. But, if you’re a good driver and you don’t have the worst luck in the world, these incidents should be few and far between. Cars are also getting safer everyday with blindspot monitoring and a variety of ways to prevent accidents from happening.

How much coverage you carry and the deductible gets into risk versus certainty. Your insurance premiums are a certainty. Every year you pay out that money even when nothing happens. It is gone. The deductible is only something that you pay out on a claim that is much more expensive to fix than your deductible. You won’t make a claim on a $600 scratch because you would still have to pay $500 of it with a $500 deductible and your insurance would probably go up.

But how often do major events happen? Well that’s impossible to know for certain but I took an educated guess using our driving history. We have had 2 accidents and 0 comprehensive incidents requiring payouts in each of our 23 years of driving. That’s one every 11.5 years but lets assume 10 years to make the math easy. What will it cost if I have an accident 10 years from now?

$500 deductible: I pay an extra $192/year in premiums plus the $500 deductable when the accident happens. $500+ ($192*10 years) = $2,420.

$2000 deductible: The current premium is the same and I pay $2,000 when the accident happens.

So I save $420 if history repeats. It gets even better though. If I invest that $192/yr premium saved into index funds at a 7% return for 10 years that $1920 turns into $2,600!

In the case of Allstate I actually benefit from a slick perk called deductible rewards. For every year you drive without an accident they reduce your deductible by $100 with it bottoming out at $100 out of pocket for you. Let’s re-run my scenario with that perk factored in.

$500 deductible w/ deductible rewards: I pay an extra $192/year in premiums but the deductible has dropped to $100 from 10 years of safe driving before the accident happens. $100 + ($192*10 years) = $2,020.

$2000 deductible w/ deductible rewards: The current premium is the same. 10 years of safe driving reduced my deductible from $2000 to $1000.

I’ve now saved $1,020 if history repeats. Even without investing the premium saved I will come out ahead as long as we don’t get into an accident any more frequently than 7 years on average.

The reward when you reduce car insurance premiums - money.
Photo by Pixabay on Pexels.com

Final Results

All told, I’m going to save $931 a year in insurance based on the changes that I made over the last 4 months. That’s a 44% reduction! The funny thing is, I still haven’t tried the common method of saving money – shopping around for insurance. I have multiple policies and I’ve been happy with my Allstate service so I’ve held off on investigating it but I’ll give that a shot next month. I’m a bit “insuranced out” at the moment.

Final premium after I reduced my car insurance.
January 2021 Premiums and Discounts

Here’s a nice tabular format showing the impact that ear change made to our premiums.

Summary of savings - reducing car insurance.

Action Steps:

  1. READ your policy. Make sure you have the coverage that you think you need. Check what deductibles you have. Are you paying for any features that you don’t care about? Towing? Roadside assistance? Rental reimbursement? Is your car old enough to consider dropping collision?
  2. READ your policy. Are all the features of your cars that can reduce premiums listed? These would be things like safety devices (daytime running lights, anti-lock brakes) and anti-theft devices.
  3. CALL your insurance company and see what kinds of changes could be made to your policy to save you money on your premiums. The things I did are some but are not an exhaustive list. Ask and see what they tell you.
  4. RUN the math on the total cost between higher premium, lower deductible and lower premium, higher deductible. This is a big premium cost driver unless you don’t have collision.

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What have you done to save on your auto insurance?

Categories
Expenses

Reduce spending! 2020 spending recap and 2021 plan

crop payroll clerk counting money while sitting at table
Photo by Karolina Grabowska on Pexels.com

Bottom Line Up Front (BLUF): Reduced spending = faster financial independence. If you want to understand where your money is going to reduce spending then you need to track your spending, summarize, review and take action!

 “What gets measured, gets improved.”

Peter Drucker

In the 1970’s a well known consultant, Peter Drucker, said those words. He was speaking in the application of business but the quote rings true in personal finance. If you want to reduce spending to save more, you have to know where the money is going.

I was never taught to track my spending so I’ve run wild with it my whole life. “Affording” something meant having the credit to buy it and having the payment fit with my paycheck income. I looked at it from a monthly cash flow perspective, not how much it was costing me overall. I don’t remember what made me do it, but after 2018 I decided to look back for the first time in my life at my yearly spending. It was pretty eye opening.

2018 Total Spending – $80,998

2018 was the first year that I sat down at the end of the year to see what I actually spent for the year. I was bit shocked. I bought a used Corvette (2nd car) that I didn’t need and paid $17,000 towards it. I spent close to $6,000 on stuff much due to Amazon! I wasted $600 for a cell phone plan that I wasn’t using. I spent $1,300 on optional company benefits (legal advice, accidental death insurance…etc) that I didn’t need or wasn’t using.

I know it was a ridiculous purchase, but come on. It was pretty.

2019 Total Spending – $87,377

In 2019 I made changes to not pay for some services that I wasn’t using and knocked down shopping by $1,000. I did however spend $17,000 buying a used car to replace my primary car – a 15 year old SUV that was up for major repairs. We took the vacation of a lifetime to South America for $15,000 that we had saved for and paid in full. Believe it or not we did find some ways to save $3,000 on that trip but this was before I learned about travel rewards. I made a few positive changes, but they were minor.

2020 Total Spending-$66,537

In 2020, I found the FI movement and really started buying into it. I cancelled services I wasn’t using. I packed my lunch every day. I sold my Corvette. It was fun to drive and I had a couple of great years with it! However, it was also expensive, something to constantly worry about and was another thing to take care of. I sold $3,200 of stuff from around the house that we weren’t using on FB marketplace and Ebay. Obviously this little world event called a pandemic reduced some entertainment spending but that wasn’t the only driver.

Saying goodbye!

Housing: Yeah, housing! Yikes. A new roof moved the needle on that one.

Food: Food was a lot less eating out and a lot more groceries.

Vacation: We had a vacation planned for May and paid for some of it before COVID forced cancellations. We also took a trip to Maine in September that was much needed.

Transportation: No more car changes! Selling the corvette reduced insurance and maintenance costs. Gas was far reduced with much more work from home.

Shopping: This is mostly Amazon food and stuff. I need to separate this better for 2021 because it wasn’t as bad as it seems.

Pets: We have an aging pooch and he is starting to have some issues😢. He had a minor surgery, extra vet visits and a bunch of daycare costs.

Healthcare: I finally looked into options to fixing my mild sleep apnea and increasing sleep quality. I had a dental device made and wow, it has been life changing! So much more energy, I don’t snore and I sleep like a rock. Most of the cost for the year was that device and associated visits.

2021 Goal Spending < $55,000

Where do we go from here to reduce spending? Well, we dive into the 2020 spending and look for any areas to optimize in 2021. Then we take action on those areas. Start with the most expensive budget areas and then work down each one. I look for things to cut that don’t add value to our lives and wouldn’t reduce happiness. For example, entertainment such as going to concerts and events makes us happy so I will keep a larger entertainment budget. On the other hand, paying for life insurance only adds value if I have the right amount. I’m wasting money if I’m overinsured.

I make a budget based on the new target spending in MS Excel and then will track to it in 2021 using You Need A Budget (YNAB). I am brand new to YNAB but I’m impressed so far so more to come on that tool in the future.

Items highlighted in yellow are areas of planned reduction in 2021 and reflect the new target values to achieve our goal budget.

2021 areas of focus:

Housing – $26,783 -> $15,103

Okay, this one feel like cheating. A new roof was needed in 2020 so that’s a $10,850 expense that we better not need anytime soon. You hear me mother nature and vermin of the world!?! On the upside it looks pretty sexy if roofs are your thing. In the home repairs category I’ll look for repair vs. replace savings and more DIY opportunities. I didn’t pay for snow plow service this year so we’ll see if I regret that. One could certainly look into more aggressive ways to reduce spending here like rent out a room or sell the house. At the moment I’m not interested in those options.

Shopping – $4,166 -> $1,500

Damn you Amazon prime and your ultimate convenience! This actually isn’t as bad as it seems as there’s a LOT of food related spending included. Protein shake ingredients, running fuel and vitamins make up a lot of it. I will categorize things better this year. That said, I still get the urge to buy something new sometimes. I’ll give the 72 hour rule from the Frugalwoods a shot – wait for 72 hours to think about it before buying non-essential items – and see how that works.

Insurance – $2,167 -> $1,500?

A bit of a downer topic, but important to talk about. How much life and disability insurance does one need? How much when you’re approaching your FI number? I’ll be explore this topic in its own post and look at whether I can eliminate or reduce this expense substantially in 2021. I have a fancy disability insurance policy costing me $1,200/yr and term life insurance for WAY more coverage than I need for $650/yr.

halloween headstones on grassy ground
Photo by Juan Vargas on Pexels.com

Food – $9,710 -> $10,400

Umm, have you lost it sir? This is supposed to be a post about reducing spending, not increasing it. Yeah yeah, I know. This one looks bad on the surface but I’m actually reducing food spending overall to hit this number. In 2020 I bought a lot of food items on Amazon but called them shopping. It’s a little bit of a shell game but I’m actually challenging myself to reduce overall food spending. Eating out was down with the pandemic but we do enjoy that occasionally so that will go back up. Usually it’s pretty affordable like this deconstructed sushi bowl, a.k.a. sushi trasher.

But, but…food!

Actionable ways to reduce spending:

  1. Track your spending! Use a spreadsheet, Mint, YNAB or something else but you MUST understand where the money is going.
  2. Lump spending into categories that work for your lifestyle.
  3. Sort by largest category to smallest by dollar amount. Start digging into each one and look into options for ways to cut down on spending where it isn’t improving your life.
  4. Keep the goal of the spending in mind when looking to optimize. If your travel costs are high and you want to visit a city for a week, the goal is to experience the city. Where you stay when there is highly variable cost with many options like hotel, AirBnB, hostel, stay with friends and house sit. Thinking about the goal keeps the solution space open to more creative ways to solve the problem.

How did you do in 2020? How are you planning to optimize or reduce spending in 2021?

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