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IT’S A TOPIC WHERE I always seem to be in the minority. The controversy: Should you save first and then spend what remains—or, instead, prepare a budget which then determines how much you can “afford” to save?
Budgets are scary and stressful. Go ahead, make a budget if you like. But if you conclude that you can’t afford to save, there’s no progress in that.
A Northwestern Mutual survey found that 49% of U.S. adults say they don’t have a clear idea of how much they can afford to spend now and how much they should be saving for later. Need greater clarity? I’ll clear it up: Start by saving 15% of your gross income.
“Afford to spend” is an interesting phrase. My contention: You can afford to spend what’s left after you save a significant portion of your gross income. What you can’t afford to do is spend more than that.
What if you save 15% of gross income and you can’t support your lifestyle with what’s left? You have to look at your spending and determine what needs to change—fewer lottery tickets perhaps, a smaller car payment, dine in rather than out, leave more of the junk food on the grocery shelf. In general, what you need is a little less discretionary spending.
You’re living paycheck to paycheck, you say? So does Elton John, I hear. For all but the lowest-income Americans, that problem reflects the amount of their spending, not the size of their income.
Richard Quinn’s mention of Elton John speaks to the clear reasoning for why, if you want to grow rich, you must “Pay Yourself First.” Mr. Quinn here is spot on:
The John example shows that (A) no matter how much money you make, (B) it’s never the exact right amount, so (C) if you pull a fixed percentage out of every paycheck, you’ll find a way to live with what’s left.
After that, (D) If you pull out the additional amount of any raise you get, you then get to live on the previous paycheck’s full amount.
With each raise after that, (E) you get more money to spend, while your savings also grows.
(F) You then won’t need to “budget” (or your budget will need to be based on the lower amount).
(G) When you get to be an old coot, you should find that you have more than enough wealth to retire on, as you see fit.
Gee!
Regards,
(($; -)}™
Gozo
I believe it’s vitally important to Pay Yourself First. When I started, the common advice was to save 10%… but pensions were still common.
For a decade we were doing great. Then our kids needed attention and medical care. For another 5 or 6 years we were in the red. We did a lot to catch up, but for another decade it felt like we were treading water, just going nowhere. It felt like we were living paycheck to paycheck, though to be real, we still were saving and investing. Then, suddenly, the switch flipped and it’s like all the little things we did over the past ten years suddenly came to fruition. Suddenly we had lots of cash flow, debt getting paid down, savings at 20%, Emergency Fund back on track. Even if that hadn’t happened, though, we’d have been ok in retirement due to decades of saving that first 15%.
Once you start saving via “Pay Yourself First,” you likely will keep finding new ways to add more savings. This is a form of “compounding” that doesn’t show up in the calculation figures.
(You could think of it as “Compounding of Opportunity.” I guess that makes compounding sort of like a law of physics. Maybe what Einstein apocryphally said about compounding was accurate in more ways than he apocryphally believed.)
Regards,
(($; -)}™
Gozo
Saving for later is a habit that is least painfully formed early in life. “later” itself is a relative concept, so a child who can save nickels for a few months could grow to an adult who can save for a house and ultimately a retirement. An ability to delay gratification can be useful and it helps to have a partner who’s also interested.
https://greatergood.berkeley.edu/article/item/kids_do_better_on_the_marshmallow_test_when_they_cooperate
The younger the saver, the smaller the income, the lower the starting point, and possibly even the shorter the length of the saving. Start at 1% at 15 years old, save a tiny bit more each year. In bad years, maybe there’s nothing to be saved, and yet it might be possible to double down in a better year before long…
Same practices apply to charitable giving.
Considering that Elton is worth $500 million I doubt he is living paycheck to paycheck despite his lavish spending.
My wife and I are comfortably retired even though neither one of us has ever formally budgeted. We both were single parents after previous marriages and experienced extended periods where we didn’t save (despite frugal behavior that including not dining out for a year). We were able to make up for that after we met and married without much difficulty because of our frugal mindsets. In my opinion, a frugal mindset is far more important than budgeting because spendthrifts have much different opinions than those who are frugal about whether an expenditure is necessary or discretionary.
I’ve never used a regular budget. I have sometimes created annual forecasts which look like budgets, just to figure out what track our savings are on, but not as a spending guide. This may require an innate sense of cash flow, to some degree.
On the other hand, a psychology of abundance often helps one build a career and earn more. This describes my wife, who is very skilled at tax and the related legal implications, but for whom cash flow is not an innate skill. Her forecasts of our savings were always best case scenarios. I’m much better at such forecasts than she is. At the same time, I proceed more from a psychology of scarcity, which may mean I forecast better but also may have limited my career and earning potential to some degree.
In the end, awareness of one’s own strengths and weaknesses is highly valuable.
He has been in the verge of bankruptcy more than once.