I am not a fan of the term “budgeting”. Never have been. Perhaps it’s the fact it has two g’s, because I’ve never liked the word boggle either ... anyway, I have always felt that it was about limits, about withholding, and certainly had nothing to do with living.
Don’t worry, I am not throwing you a curve ball here, I honestly think that we are put on this earth to live, not to squirrel away our coins for some vague and far away “future”. However, I also think that, as a planet, we shamefully waste the resources we have, spend them on meaningless things, and miss out on the amazing moments life can bring.
So by working through the rules so far, hopefully you can see the benefit of spending less than you earn, and even have some ways you can increase the gap so you have more to put aside.
The next skill we need to develop is the art of Intentional Spending.
Intentional Spending (as opposed to its boring cousin, Budgeting) involves planning for major expenses in advance.
What do I mean by that? Well, whether it is crazy spending on Christmas presents, an annual holiday, or the major car service you know is coming, many people get to a major event and suddenly realise they need to take action, spend a load of money and come out of it with major credit card pain.
I hope you now agree that credit cards really are evil minions, and you are receptive to an alternate way of approaching these highly predictable events.
The trick is to work your way up to them.
Let’s take Christmas presents. I don’t know about you, but we burn some serious dough on Christmas presents. This shouldn’t be a surprise – we know the date is coming, and even the number of gifts we need to purchase and the approximate spending amount is pretty much a given. However, up until the last year or two, every year we end up running around like idiots in the few weeks before Christmas trying to come up with gift ideas
So how about we approach this event in advance ... say July?
We know how much we will end up spending broadly (multiply the number of people by the average amount you’ll spend on a gift), so let’s start putting away 1/6th of that every month from July to December in preparation for the craziness. If it helps, set up a new bank account to help you keep that money separate from your general savings account. And even better, get a Visa Debit card attached to that account that you know is only for spending on Christmas presents for your loved ones.
When you come closer to the proposed spending occasion, not only will you feel immense satisfaction at having put aside enough money for the event but, if you manage to get a few good deals, you may even be able to treat yourself to something nice!
You will find that when you have put aside the money over time, you are far less likely to go over budget when you do spend. And when you are taking it out of your day-to-day spending, you get a far better sense of what you can afford, as you start to work out how much room you have available in your cash flow for other intentional spending items.
There are some very cooperative banks that will even let you set up sub-accounts within your bank account – this is an awesome way of keeping track of your future spending plans. Think of them as “tins” you put money in. You might have one for your annual holiday, one for Christmas presents, one for some landscaping you would like to get done ... whatever is a major expense that can be gradually saved for.
So that is Intentional Spending. Knowing how much you have, and putting money aside from what’s left, well in advance for future spending items.
I also want to be clear, saving a whole lot of money over five years and then blowing it on something you only just thought of or came across is NOT Intentional Spending. If this item wasn’t in your mind the whole time you were putting money aside, then I question why you are buying it at all.
The trick is to identify the item you will have to buy in the future, work out how much it will cost (approximately) and then put money aside for it.
Can I afford this?
This is a question I frequently get asked by prospective clients when they are looking at a major purchase.
The key to understanding this is to know what is left after your current level of spending. Let’s imagine you are considering an annual holiday to Italy which will cost $10,000 for you and your partner. Can you afford this?
Let’s start by getting a bit more information:
When were you hoping to go?
Does the $10,000 include all travel, accommodation and entertainment costs?
Let’s imagine the answers are in 12 months, and that the $10,000 is your best guess of the absolute total dollars you would need for this exciting trip.
The way to work out if you can afford this is to therefore take the $10,000 and divide it into the 12 months between now and then. If your cash flow doesn’t have enough extra to put aside $833 a month, then unfortunately I would say that no, you can’t afford the trip.
Don’t take this as a hard no; we just need to reconsider the parameters. What about making the trip in two years instead of one? Then you only need to put aside $417 a month.
Hopefully that is workable and you can juggle a few of your spending habits to put that aside. You may even find, as you start putting money into your “Italy Extravaganza” account, that you are so focused on the end goal that you are putting extra away. Perhaps you might have to go earlier? What an awesome problem to have!
What if you have crunched the numbers and you still can’t put aside that amount a month?
The temptation in these situations is to “just put it on the credit card”. Perhaps you are convinced that credit cards shouldn’t be used for the day-to-day, but are appropriate for big-ticket items like this.
Let me set you straight.
In the above situation, even if you plan to save over two years, you don’t think you could put aside $417 a month. You therefore decide to throw caution to the wind and put the holiday on a credit card.
Let’s step through the most likely outcome:
You go on your lovely holiday; however, because you weren’t spending intentionally and just used your credit card to pay for everything, you lost track of your planned $10,000 total cost and ended up spending $12,000.
When you get back from your holiday and the glow has worn off, you get your credit card bill and start paying it off.
You can afford to pay $300 a month to reduce the amount you owe, and you figure you should be able to pay it off fairly quickly because that isn’t much less than saving $417 a month, right?
At a 20% credit card rate, paying $300 a month, it ends up taking you five and a half years to pay off your holiday, and your repayments total $19,940.
Your $10,000 holiday ends up costing you $19,940 and nearly six years of your life.
And don’t forget, during that time your ability to save or plan for any other major spends will be taken away as you will be applying all your spare dollars to paying off your holiday. How depressing.
The truth is, you couldn’t afford the holiday. The way to spot this? If you can’t put money aside for it in advance, you probably can’t afford it.
That doesn’t mean you don’t go on one, ever. It simply means you adjust your future plans for holidays or other items for which you can save. Perhaps it changes from a trip to Italy to a more local holiday. You could make it shorter, or stay in less luxurious hotels. Either way, get your intended spend to the point where you feel comfortable you could put that aside over the next year or two and get started.
I have used a holiday as an example here, as it is fun and exciting; however, the same logic applies to any major expense you would otherwise just put on the credit card.
Plan, plan, plan!
Practice makes perfect
The same sort of forethought we have used above can be used to prepare for other big things, but in a slightly different way.
Perhaps you are working towards buying your first home. You have a broad idea of what price range you are looking at and how much you therefore need to borrow. You may even have already saved your deposit. It’s starting to get exciting, however you are just a little nervous about the major commitment you are about to take on.
I would suggest that the best way to work out if you are going to be able to cope with that purchase and its matching debt is to practice.
Practice?
What I mean is that if you know how much your monthly mortgage repayments are going to be, then put that money aside every month for the next three months. Make sure you adjust for the rent you are currently paying; however, keep track of whether you are able to put aside that monthly mortgage repayment amount while still paying your bills and keeping your head above water.
sing actual dollar amounts, if you are paying $1,000 in rent a month, and the mortgage on your new home would be approximately $2,000 a month, then make sure that you can put aside an additional $1,000 on top of paying your rent.
I have had young couples who did this and realised that, to manage the repayments, their lives would have to end. They would literally have to stop doing anything outside of being at home and at work. Practising had highlighted for them that the price range they were looking at was out of their reach or, more importantly, was too big a trade-off. They therefore adjusted the locations they looked at, bought in a lower price and manage to have a modest, but enjoyable, life without being restricted to eating only bread and water.