Spending is the topic that seems to be the focus of most accountants and personal finance people. Working on and developing budgets is their primary task.
While it is important, it can get in the way, be a time-killer, and discourage most people from focusing on their finances. A lot of people would disagree but they tend to be the kind that love working on budgets and spending time mired in the details, ones who love to research where they spent that last $1.97 and place it in its proper category so that everything is in balance.
We need accountants, heck I am one. But most people can’t and won’t do what accountants do.
What is a better solution?
In keeping in line with what I’ve learned that works, the simple approach is the way to go. Here are my life lessons when it comes to spending.
1. Spend less than you make – if you can only master one of these, this would be it. When you don’t follow this rule your only option is to spend with credit which builds up your debt, which builds up the amount you spend on interest and you become a slave to it.
2. Stash away money so you can’t spend it – This is the secret to rule #1. Most people will spend money they have. It is burning a hole in their pockets. If your wallet is empty and your credit card is home you can’t spend. If the checking account is lower this month because you had $500 automatically deposited into savings accounts then you learn to spend with what is left over.
3. Focus on the big ticket items – Most budgets fail because they track every little penny in every little category. Accountants live in that world, most people don’t. Keep your spending categories simple; house, cars, food, other.
4. Housing – Compare what you spend on housing to what is recommended – If you’ve spent over 35% of your income on housing, you’re on the high side. This includes your mortgage, real estate taxes and utilities. Consider downsizing, renting, or moving to a cheaper location. These are not decisions that can be made quickly, but it is good to start thinking about them. Can’t sell your house? Can you rent it out and then buy something smaller for your family? No? Can you rent out a room to a family member? No? Can you raise your income through a promotion , job/career change or part-time job so that your housing percentage decreases?
5. Cars – a quick rule of thumb is to spend 25% of your income on your car purchase – If you make $50,000 per year then spend $12,500 on your car (that’s total purchase price, not total annual car payments). Your car expense should not be more than 10% of your income. It is not a lot, but it will get you a decent used Honda Civic or Toyota Corolla. Do you have two cars but one of you takes the train to work? Consider selling one of the cars or at least trading down to an inexpensive second car.
6. Food – Aim to spend 10% of your income on food – If you are spending more than this look to see how many times you are eating out for lunch and dinner. Can you bring your lunch or cook less expensive dinners, eat chicken instead of steak, stock up on meat when it is on sale…This can be a simple one to correct or it can be very difficult. You may have to change your behavior or likes to get down to the 10% level. If you’re at 15%, start small and reduce to 14% and gradually over time bring this down to 10%.
7. Other – The top three account for 55% (house-35%, cars-10%, food-10%) of your income. We’ve talked previously about the importance of saving and debt reduction, so if you allocate 10% each to those categories you are left with 25% for charity, insurance, medical, fun, clothes…
As you can see above, the top three will account for over half of your income, at least initially. Once you eliminate your debt, the amount of your income you are spending on your house, cars and debt reduction drops a huge amount, leaving you with more money to save or spend on luxuries.
You may be thinking “I’ve already bought my house and cars, I am locked in.” In the short term you may be, but start to think about what you could start planning for; moving, downsizing, selling a car, brown-bagging lunch, home-cooked meals…
My wife and I are already planning on downsizing our home and moving to another state with a lower cost of living, possibly even renting instead of buying, freeing up all the cash for investing and allowing us to quickly move again if we decide that new state is not where we want to live.
In the next lesson, I talk about the biggest mistake people make when thinking long term.
Note: If you’ve missed the first four lessons, here are the links: