“Create a budget!” is the sort of redundant advice
that personal-finance experts feel good prescribing, yet when real people read
about making a budget, their eyes glaze over faster than a fat girl’s lips at
Krispy Kreme. Who wants to track their spending? The few people who actually
try it find that their budgets completely fail after a few days because tracking
every penny is overwhelming. A 2007 survey by bankrate.com, 75 percent of
Americans said they have a budget—which is complete nonsense.
The Difference between Cheap and Frugal
Let’s first dispense with the idea that saying no to
spending on certain things means you’re cheap. If you decide that spending
$2.50 on Cokes when you eat out isn’t worth it—and you’d rather save that $15
each week for a haircut—that’s not cheap. That’s using frugality to drive
conscious spending. (Hence the name of this blog being Frugal Freddy…)Unfortunately,
most Americans dismiss frugality because they confuse it with cheapness,
thinking that frugality is all-or-nothing: “Frugal people don’t spend money on
anything! I’m never going to cut all my spending, so forget it.”
Frugality isn't just about our own choices, though.
There’s also the social influence to spend. Call it the Real House Wives/
Air Jordan’s effect…. (FYI 95% them are broke in real life) where your
friends’ spending directly affects yours. Next time you go to the mall, check
out any random group of friends. Chances are, they’re dressed similarly—even
though chances are good that they have wildly different incomes.
Frugality isn't about cutting your spending on
everything. That approach wouldn't last two days. Frugality, quite simply, is
about choosing the things you love enough to spend extravagantly on—and then
cutting costs mercilessly on the things you don’t love.
Conscious Spending Plan
A Conscious Spending Plan involves four major
buckets where your money will go: Fixed Costs, Investments, Savings, and
Guilt-free Spending Money.
MONTHLY FIXED COSTS
Fixed costs are the amounts you must pay, like your
rent/mortgage, utilities, cell phone, and student loans. A good rule of thumb
is that fixed costs should be 50–60 percent of your take-home pay. Before you
can do anything else, you’ve got to figure out how much these add up to.
Check out the chart on the next page with common
basic expenses (the bare minimum that any ordinary person would use to live).
If you see any glaring omissions for major spending categories, add them.
Notice that I didn’t include “eating out” or “entertainment,” as those come out
of the guilt-free spending category.
LONG-TERM INVESTMENTS
This bucket includes the amount you’ll send to your
401(k) and Roth IRA each month. A good rule of thumb is to invest 10 percent of
your take-home pay (after taxes, or the amount on your monthly paycheck) for
the long term. Your 401(k) contributions count toward the 10 percent, so if you
already participate in a 401(k), you’ll need to add that amount to your
take-home money to get a total monthly salary.
SAVINGS GOALS
This bucket includes short-term savings goals (like
Christmas gifts and vacation), midterm savings goals (a wedding in a few
years), and larger, longer term goals (like a down payment on a house).
To determine how much you should be putting away
each month, check out these examples. They’ll shock you:
GIFTS FOR FRIENDS AND FAMILY. In
2011 Americans spent around $900 on Christmas gifts. If you’re an average
consumer and want to pay for your gifts without going into debt, that means you
need to save $75/month for your Christmas gifts. (And what about birthday
gifts?)
YOUR WEDDING (WHETHER YOU’RE ENGAGED OR
NOT). The average wedding costs about $28,000. The average
wedding age is twenty-seven for men and twenty-six for women, you can figure
out exactly how much you need to be saving, assuming you want to pay for it
without help or debt: If you’re twenty-five years old, you need to be saving
more than $1,000/month for your wedding. If you’re twenty-six, you should be
saving more than $2,300/month.
BUYING A HOUSE. If
you’re thinking about buying a house in a few years, log on to www.zillow.com and
check home prices in your area. Let’s just say the average house in your
neighborhood costs $300,000 and you want to do a traditional 20 percent down
payment. That’s $60,000, so if you want to buy a house in five years, you
should be saving $1,000/month. Crazy, right? Nobody thinks like this, but it’s
truly eye-opening when you plot out your future spending for the next few
years. It can almost seem overwhelming, but there’s good news: The longer you
have to save for these things, the less you have to save each month.
GUILT-FREE SPENDING MONEY
After all that spending, investing, and saving, this
bucket contains the fun money—the stuff you can use for anything you want,
guilt-free. Money here covers things like going out to restaurants and bars,
movies, and vacations.
Depending on how you've structured your other
buckets, a good rule of thumb here is to use 20 percent to 35 percent of your
take-home income for guilt-free spending money.
SET REALISTIC GOALS
Though it might not seem
like a big deal, small distinctions make all the difference in the world...i.e.
simply “saving” versus “saving for a down payment”. Saving with a goal—whether
it’s tangible like a house or intangible like your master’s degree—puts all
your decisions into focus.
SET UP A
SPECIFIC ACCOUNT. Another key difference was how I was
saving. I opened up an Ally savings account and named 3 accounts “Down Payment,
Vacation, and School” and regularly transfer in the amount I had determined I
wanted to save each month.
USE THE
ENVELOPE SYSTEM TO TARGET YOUR BIG WINS
All this conscious spending and optimizing sounds nice in theory, but
how do you do it? I recommend the envelope system, in which you allocate money for
certain categories like eating out, shopping, rent, and so on. Once you spend
the money for that month, that’s it: You can’t spend more. If it’s really an emergency,
you can dip into other envelopes at the cost of spending in that category.
These “envelopes” can be figurative (like in Mint or Excel) or literally envelopes
that you put cash in. This is the best system I've found for keeping spending
simple and sustainable.
And when it’s gone, it’s gone.
The best part about
setting up a strategic budget is that it guides your decisions, letting
you say no much more easily—“Sorry, it’s not in my plan this month”—and freeing
you up to enjoy what you do spend on. This is guilt-free spending at its best.
Tiger Tracks WEEK FOUR:
1) Get your paycheck,
determine what you’ve been spending, and figure out what your Conscious
Spending Plan should look like. Don’t
over think it. Just break your take-home income into chunks of fixed costs
(50–60 percent), long-term investments (10 percent), savings goals (5–10
percent), and guilt-free spending money (20–35 percent).
2) Optimize your
spending
3) Maintain your
Conscious Spending Plan
