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Posted by on Feb 3, 2010 in Lifestyle, TG Roundup

A Six-Step Approach to Reducing Cost of Living

[Via – Shyam’s Column]

Common sense technique coupled with out-of-the-box thinking can help slash your living expenses.

Over the last few weeks, the missus and I have been trying to ‘optimize’ (euphemism for cutting) our living expenses. The reason for this sudden frugality exercise? Well, for once, the missus has agreed that continuously striving for greater earnings might not be such a foolproof strategy for increasing our savings, especially given the vagaries of the economic environment. Moreover, lately there has been a feeling that our expenses increase with earnings, just like the old saying – “work expands to fill the time available”. With both our companies going to great lengths to save costs, we thought the timing could not be better to start our pet project on household cost saving. Here we share with you a simple but effective approach to cost saving that worked for our family.

Step 1: Annualize expenses

Our brains don’t seem to be programmed to take small numbers seriously. This is one of the reasons why we don’t feel the guilt when we indulge in items that cost less on a per unit basis. But it could be that all these seemingly harmless small indulgences, over an entire year, could turn out to be much more expensive than some of the larger one-off expenses. The only way to cheat our brain in this (and help it visualize better) is to annualize the typical expenses that we incur in a month, under various heads, by multiplying them by 12. Obviously before doing this, you need to note down what are your expenses in a typical month, item wise, including your loan EMIs.

Some people may disagree with including EMIs. Here I think it may be a good idea to make a few assumptions: 1) EMIs going towards investment plans will create assets worth atleast the value of investment that goes into it and are hence not an expense 2) loan EMIs that do not create an asset or create a depreciating asset (e.g. a car) are an expense (so you don’t splurge on such loans) 3) in the case of home EMI, only the interest portion is an expense (this way you know that it’s better to pay it off sooner rather than later). Please note that the above are mere thumb rules.

Once you annualize the expenses on your monthly list, add to it any one-off expenses that you typically incur in a year e.g. a vacation. Now you have the annualized and itemized list of expenditure to work on. The first thing that’s going to pop out is the total annual expenses that you incur. Many people faint at this stage, because they have never bothered to actually find out how much they spend in a year! But once you have an idea of this number, you can find out how much you can potentially save in the current scenario by comparing your expenses with your annual take-home income. While doing this comparison, just keep in mind that it may be a good idea to add an additional 10% to your expense list to 1) accommodate any unexpected expenses that you may incur during the course of a year 2) account for any underestimation in your other expenses.

When we did this exercise, the first thing that shocked us was how much we spend on eating outside. The missus and myself, both being foodies, usually eat out about three times a week, so much so that it has become the primary entertainment. Separately, a weekend lunch or dinner bill for two people may not seem exorbitant; but when annualized, the amount works out to an eye-popping number!

Step 2: Fix your percentage target for cost saving

This would depend on your comfort level about the gap between your income and total expenditure. We think a 10% reduction would be an ambitious target to begin with.

Step 3: Re-arrange the annual itemized list in descending order of expenditure

Just glancing at this list, can throw some surprises in terms of things that you thought were less expensive but have turned out to be higher and vice versa.

Step 4: Mark each item as discretionary/ non-discretionary

If need be you can prepare two separate lists for discretionary and non-discretionary items. What you need to keep in mind though: neither are all non-discretionary expenses (e.g. house rent) sacrosanct nor all discretionary expenses (e.g. a movie) a waste. What’s needed is out of the box thinking that questions both kinds of expenses, and creative ways to eliminate them or come up with cheaper substitutes. Few examples: 1) switching to a smaller car, car-pooling or using metro/ MRTS to reduce transport expenses 2) repaying a loan out of your annual bonus to reduce your EMI 3) Avoiding buy now- pay later schemes.

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