At their simplest, expenses really fall into two different categories:
1. What you need: the things that you need to survive and function effectively in society: food, heat/electricity, a means of transportation, clothing, and water. I’ll even throw in basic telecom and insurance.
2. What you want: everything else.
The problem, of course, is that even in the category of things we “need”, there is a ton of grey area.
“Transportation”, for example, could mean a lot of things, based on an individuals interpretation. It could mean a pair of shoes, a bike, a bus pass, a subway pass, a POS car, or a $50,000 all-wheel drive luxury SUV that gets 15 miles per gallon.
“Food” could be translated into cheap bulk generic grocery purchases only or getting sushi for takeout every night and feeding Fido prime rib.
“Telecom” could be a $10/month prepaid plan or high speed internet, VOIP, and unlimited 4G on a brand new iPhone.
Justifying Our Purchases: Making Wants Needs
The end result is that most of us err to the market standard (which is ever-increasing), as determined by marketers and subsequently, our peers. We all strive for acceptance, we are social beings by nature.
Our brains are naturally hard-wired to do things like justifying upgrading from a serviceable car to a brand new base model. And then from a base model to a loaded model. We ask ourselves rhetorical questions in order to build a case for the justification (and soften the guilt after the purchase):
- “Why replace a radiator when the engine might go any day? I should get rid of this before it goes completely.”
- “Why get base model steel wheels? People want alloy wheels, and when I go to sell the car, I don’t want to have trouble selling it.” (side note: steel wheels are WAY more durable, providing a better driving experience and less tire wear)
- “I want to be safe in the winter, so I should get 4-wheel drive.”
- “If I’m going to spend this much on a car, I might as well get the color I want.”
- “The hybrid version gets 5 more miles per gallon. I want to help save the environment.”
Over time, these nagging consumer battles in our heads tend to wear us down until eventually we give in and wants become needs (with lifestyle creep and lifestyle inflation ensuing). That is common, yet dangerous territory.
Cutting down on impulse purchases from the aforementioned “want” category is a key pillar of sound personal finance strategy (I’ll address in further detail in an upcoming post). But more importantly, perhaps, is turning the grey area in the needs category into black and white. These, after all, are the expenses that we usually pay for every single month. It’s a totally different game that requires a bit more effort and discipline.
Separating Wants and Needs
My best suggestion on how to do this is to go through this 4-step process:
- Document your average monthly expenses in each category using this spreadsheet: If you’ve used my older budget spreadsheet in the past, you probably already have totals handy. It wouldn’t hurt to update them and plug them in to the new spreadsheet. If you haven’t already done this, credit card & bank statements should be all you need. It shouldn’t take more than an hour or so to do. Note: you’ll need to sign in to Google Docs to make a copy of the spreadsheet to edit.
- How low can you go? You see what you are spending (column b), but how low can you reasonably take each category (column c)? Take justification out of this step – you need to be 100% honest with yourself in order to make this work (it won’t be easy). If you want a few suggestions, check out my list of money saving products & services that I recommend. I suspect you’ll find that food, transportation, rent/mortgage, and telecom are the areas where you will have the biggest discrepancy between your current spend and your lowest reasonable spend. The spreadsheet to help you track the difference, and annual savings. I would strongly encourage you to plug the monthly savings numbers into an investment calculator and assume an 8% annual rate of return for the next few decades to see the true financial opportunity lost.
- Switch for two months. In each category, try switching to the lower priced alternative for two months, minimum. If you have a car, try biking/walking/busing/carpooling to work for two months. If you dine out a lot, try only cooking at home for two months. If you have cable, try going without it for two months. You get the idea. To prevent shock, try just one or two categories at the same time. It will be a life changing experience, guaranteed.
- Ask yourself one question after the two months is up: “Is my financial independence worth compromising for the (fill in the blank higher cost) alternative?” Any time you try justifying making the jump to the more expensive alternative, refer back to the spreadsheet and this question.
The Long-Term Impact
Sacrifice is in the eye of the beholder. Some of the possible changes you could make may seem difficult at first – a huge sacrifice – but a year or two from now, you may have a completely different perspective. Who knows, you may just find out that you like your new found frugality.
If you don’t think this practice could have a big impact on your financial situation over time, consider this example:
You are 25 years old and spend $400 per month for auto payments for the next 50 years. If you were to instead go with a used car that costs you $150 per month (for a $250 per month savings) you’d save $150,000. If you invested that money and got an 8% annual return over those 50 years, you would have just shy of $2 million! That is much higher than the average retirement savings (just over $18,000), and most people will never get to that level. This example does not take inflation into account (I shudder to think what a new car payment will be in 50 years), which would further add to the overall cost. And this is only one common monthly expense.
Debatable sacrifice. Huge Payoff. That is the goal here.
Wants Vs. Needs Discussion:
- How do you separate wants from needs? What tips do you have from others?
- How much could you be saving per month, according to the exercise?
- What categories could you be saving the most in?
- What kind of purchase justification discussions have you had with yourself?