Annual income twenty pounds, annual expenditure nineteen pounds nineteen shillings and six pence, result happiness.

Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

Charles Dickens, David Copperfield

At the centre of most definitions of financial independence is the ability to meet current expenditure through income generated from a portfolio of assets. Earlier this year I started monthly reporting of how close the FI portfolio was to being able to meet an estimate of total annual expenses of $96 000 per annum.

This expenses figure was a rough estimate of total current spending, and resulted from adding some known fixed expenses to my total average credit card expenditure. Yet this figure has seemed higher than anticipated, so this analysis examines what my record of actual past spending suggests for a reasonable estimate of current and future spending.

Just as provisioning a ship for a voyage should take into account actual journey time, my own FI measures need to be as accurate as feasible to make sure plans are set based on realistic estimates. This article – it should be emphasised – is focused on reaching the right estimate for my personal circumstances. Its focus is not offering advice on the process of budgeting or achieving a high savings rate, subjects better covered by others.

Drawing up the manifest – reviewing the initial estimate

The process for estimating total expenditure at around $96 000 was simple in principle. It involved adding a number of known individual fixed expenses to the past twelve months of actual credit card spending. Examples of these fixed expenses include: utilities, local government rates and insurances. They also include some irregular items, such as contributions to housing repairs and a sinking cash fund for car replacement over time.

These fixed expenses are not typically paid by credit card, and so the logic was that the sum of these and the annual credit card total would reach a total overall spending estimate.

In doing this calculation, however, I overlooked that for some large annual expenses that I set aside money for regularly and which I had counted as fixed expenses, I have actually used my credit card for some or all of final payments. This applied to health insurance and some car related costs, for example.

This had the effect of double counting a couple of large expenses, because I was counting both the cash set aside monthly to meet the future cost as an expense, and also the actual expense as incurred through the credit card.

Re-estimating the level of current expenses

Over the past month I have removed the double-counted items and re-estimated all fixed expenses based on the latest actual bills. Indeed, I have allowed some small headroom across the board to allow for modest price increases in the year ahead.

The impact of this is quite significant.

The effect of removing the double-counting is to reduce the monthly fixed expenses estimate from $2 025 to $1 414. This means fixed expenses are around 30 per cent below initial estimates. In turn, this permits some revised estimate of total expenses to be made. Using thus adjusted and corrected data, expenditure appears to be:

• $7 420 per month or $89 000 per year if based on average credit card expenses of around $6000 per month since 2013; or
• $7 000 per month or $84 000 per year if based on average credit card expenses of around $5 800 per month over the past year

Both of these figures are below the original $96 000 (or $8 000 per month) total expenditure estimate.

The chart below compares the revised figures against monthly income and expenditure estimates, including the income targets that are contained in both of my FI objectives as well as a historical average of portfolio distributions.

The revised total expenditure estimate also makes it possibly to present a more accurate and less inflated picture of month to month expenditure compared to portfolio distributions received. Adjusted to account for the new estimate, the monthly progress is set out in the revised chart below.

Implications for measures of progress and required FI portfolio

The new estimates for total spending show that I have been materially overestimating current expenditure.

A benefit of recognising this is that it immediately brings forward the progress I have made against the “total expenses” benchmark reported each month. Using last months portfolio value and the $89 000 per year spending estimate, for example, it brings progress to meeting this benchmark from 74.9 per cent to 80.8 per cent.

This is a more than five percent advance in apparent progress simply from a more accurate estimate. The revised spending figure also makes the chart below – the proportion of monthly total expenses met by current distributions, look more encouraging still.

Viewed in a different way, the revised spending figure reduces the total FI portfolio required by around $167 000. This represents months and years of saving and investment now not needed, and potentially returned in the form of free time.

A further implication is that the second estimate above which uses the past 12 month of credit card expenses is within a small margin of my Objective #2 target income (of $83 000 per annum). This gives some confidence that this target is set approximately at the level of my current expenses. That is, reaching this target my current standard of living could be maintained in the absence of any employment income.

Summary 

So far historical data from credit card and additional fixed costs have been drawn on to seek to answer the question: what level of provisioning for future spending is warranted?

The analysis shows that:

• The total expenditure benchmark being targeted was set too high – When corrected for double counting and using history as a guide average total expenditure is closer to $89 000 rather than $96 000 per annum.
• A new lower and more realistic benchmark is needed – Based on this, I intend to replace my total expenditure assumption from next month, reducing it from $96 000 to $89 000. This is a conservative figure which is based on the sum of the average credit card expenditure over more than five years and the more recent accurate individual fixed cost estimates.
• The income target under Objective #2 is close to my current spending level – This lessens the chance that adjusting to the income it produces will be difficult when this this portfolio level is achieved.
• The past years spending is significantly lower than the average since 2013 – with credit card expenses of around $67 000 annually or $5 800 per month.

Taking the time to carefully consider current and future expenses can be painstaking work. It will be critical, however, to ensure the avoidance of the second of Micawber’s income and expense scenarios, and the need to rest plans for the voyage on the hope that something will turn up.