Thursday, 19 September 2013

If you find budgeting hard try 'Expenditure Smoothing'

Expenditure Smoothing (as far as I know) is not an actual financial term but it is what a lot of sensible people do to save for and pay for large expenditures that they have coming up.  I have adapted the basic principle to make it broader and have been using it for a few months now and it is working rather well so I thought I would share it here.

The principle is fairly basic:
If you have a large expenditure coming up that you know about, you spread the cost over as long a period as possible.  That is you start to save today (even if you can afford it in the future) for something where you don't have to pay into the future.
This is not any great insight.  People do this for holidays all the time - they know they are going on holidays in 6 months time so they start putting money away today so that they can pay for their airfares and accommodation and also have spending money.

You can use this principle for almost any large expenditure

Most people only use it for expenditures where there is a significant amount of planning involved (i.e. holidays) but I'm advocating using it much more broadly.  Any example you can think of which may blow up your budget, you can start to save for it early and then it costs you very little when the expenditure actually comes up.

For example, guys who are reading this - if you have been seeing your girlfriend for a little while and think that she may be the one you want to marry at some point (though are not super sure yet and want to give it more time) and you think you may propose in a year or 18 months then saving $300 a month starting this month means you'll have $5,400 in 18 months with which to buy the ring (and it doesn't blow up your savings plan around that time).

It may sound like I'm just advocating saving and I sort of am but this is about saving incremental amounts for specific (NOT general) expenditures.  I am going to outline below how you can actually implement the plan effectively.

You can also use this for unexpected expenditures

You can get the greatest benefit out of this sort of plan when you know the expenditure is coming up.  With the ring example above you can split the cost over 18 months which makes it super affordable.  However you can also use this plan for unexpected expenditures.

It is really quite simple.  If you get a bill that was
unexpected or you didn't know how much it would be (for example car registration, insurance, car maintenance) what you can do is pay the bill on your credit card at  the very start of your credit card cycle.  Most credit cards give you 55 days interest free which means you really need to pay it 2 billing cycles from now.  This allows you to spread this expenditure over 3 paychecks rather than getting unexpectedly slammed in one pay check.

I also use it to spread large outings which I typically put on my credit card.  For example if I go out for a fancy dinner and spend $200 on my credit card instead of having this bill come up next month and have to fund it then, I use cash in my bank account today to save for half this amount and so spread a big night over two months.

So how do you implement the plan?

It is a really easy plan but it requires you to be consistent

  1. Open up a new high interest savings account which is exclusively for this expenditure spreading
  2. For every goal you have use a different title when you transfer money into this account
    • For example for the ring I use 'ring saver' when I transfer money in
    • For the holiday I use 'Holiday Saver Nov13'
    • For money that is going to be used to pay off credit cards use the date the payment is due.  I use 'CC Hold for Oct13'
  3. When the expenditure actually comes up, go through this account statement, add up every time you see the same label (for example CC Hold for Oct 13) and then transfer this amount to the account you are going t pay it from
What are the benefits of Expenditure Smoothing?

There are two big benefits (as I see it)
  • Your savings and investment plan never really gets blown up because you are spreading the impact of any big expenditures over time (i.e. smoothing)
  • You get more disciplined about using credit.  If you have to back up every big purchase on credit with cash then you tend to think about it a lot more
Try it and see if it works for you.  At worst you'll have a little bit more saved up in a savings account.  

You May Also Be Interested In


  1. You should look into a piece of software called YNAB. It helps manage and fund larger expenses by breaking them into monthly pieces over a year.
    It really helps to get a better handle over categories of spending and puts you in control of money in a single account without needing multiple savings accounts to track balances. This earmarking of funds helps get away from using your credit card to bridge gaps in spending.

    1. Hi William - my fiancee actually uses that. It's great and super easy to use for predictable expenses but I found it doesn't work so well for unexpected bills.

      It is a really good tool though!