The first step to a solid financial foundation is a lean budget. You’ll never be able to invest and achieve big-time wealth if your finances are tied up in housing costs, vehicle payments and drive-through cappuccinos .
I’m going to try to convince you, in one table, that spending significantly less than what you earn is the only way to make it to financial freedom. The table below shows you how old you’ll be when you can retire depending on your savings rate. It does not matter if you are making $40,000/year or $300,000/year, the math will work out to be the same.
Assumptions: 6% annualized interest, annual raise = inflation, you start saving at age 21, and you withdraw from your retirement fund at an annual “safe withdrawal” rate of 4%. Retirement age is rounded up to the nearest integer.
As you can see in the assumptions, if you start saving the commonly-preached “10%” for retirement, you’re going to be 66 when you can retire. That is old! I believe all people should strive for a 20% retirement savings rate. This allows the flexibility of an earlier retirement. If you want to keep working past your retirement age because you enjoy your work, then that’s awesome. You won’t be held hostage by your cubicle though. Long past the glory days of your 21st birthday? You’re going to need to step up your game. See the post on Phase 3.
Do you see now that it doesn’t matter what you make, but instead how much you spend?
I’m not a big believer in establishing percentages for needs/wants/savings because it gives you a sense of “well, I haven’t hit my 30% for wants yet, so I can spend a little more”. Negative, ghost rider! The whole point here is to decrease all spending to what you truly need. This is less about throwing up numbers for different categories and more about tracking and reducing your spending.
Here are some general rules to follow:
- Keep housing costs at 30% of your net (post-tax) income
- $60 per adult, per week for food (we’ll show you how later)
- $0 for car payments (yes, that’s a zero)
- Ditch the cable/satellite TV.
“I’m not going to have any fun,” you say. Nonsense. I think back to when I was in college when, aside from housing expenses, I had $300/month (this is 2008 dollars, which equates to $331 in 2015 dollars) to spend on all food, entertainment, and alcohol. Three-hundred A MONTH. There are some people now who walk out of the grocery store spending more than that. Yet, somehow, some of my fondest memories are from when I was in school. It’s all about frame of mind. There is no happiness except that which you make.
Unless you’ve got credit card debt or a car payment, you can enjoy a restaurant here or there, but keep it to a minimum. Not once a week minimum, but a once every-other-week minimum. Just try it. You’ll find that eating out is more enjoyable when you don’t do it all the time.
Ah yes. The car payment. Yes, that one. If you can’t pay it off right now, you shouldn’t have bought it in the first place. For some perverted reason, it is ingrained in our culture that it is normal to have a car payment. Seriously?! I just pulled up a 2005 Toyota Corolla for $4k on cars.com. Don’t be scared of cars with mileage around 100,000. This isn’t the 1970s; cars are much more reliable than they used to be. I personally own a 2005 Corolla with over 141,000 miles. It gets driven every day to work, it has never broken down, and the only maintenance I’ve had to do is normal wear and tear like oil and brakes. If you’re still hung up on it, convince yourself it is only temporary. Just try it for one year. Oh yea and one other thing… People don’t give a shit about the car you drive. They’re too worried about their own image. In fact, there is something highly satisfying about pulling up in a beater, because it means you’ve figured it out while the rest of those poor saps around you haven’t. A $300/month car payment means you are seriously missing out. If you continuously had invested that amount for 10 years, that works out to more than $50,000 (assuming 6% interest)!
Ok so you’ve heard this all before and you still don’t know where to start. Here are your action items.
This is what you need to do to complete Phase 1
- Track your spending in different areas over the past three months. You can do this manually or with software such as Personal Capital (free) or Mint (free). With either of these programs, you simply link in your bank accounts and it does the rest.
- Calculate your average monthly spending from the last three months. Write that number down. You may be asking “what about those one-off expenses?” An expense is an expense is an expense. It is easy to justify spending as “oh, it was just a one time thing”. Yes, that may be true, but you still spent the money and those expenditures DO come up from time to time and they need to be accounted for in your budget. Justifying one-off expenses as an exception enables excessive spending and we don’t want that.
- Cut your baseline spending by 20% over the next month. Multiply your previous month’s spending by 0.8 to see what you need to get to. Here are some of the easiest ways to make an impact:
- Call up the cable company and cancel your cable TV. It’ll free up money and time to do more productive things.
- Head over to Budget Bytes so you can cut your grocery bill. Make enough dinner so that you have leftovers for lunch the next day. Use store brand instead of brand-name.
- Stop going to restaurants and fast food. Now. Want to celebrate the weekend? Invite some friends over and cook dinner together. You supply the ingredients and they supply the wine. Cook together. There are TONS of 4-person meals out there for less than 20 bucks. Home-made pizza (Get the Trader Joe’s garlic herb crust for $2.50… You can thank me later) is one of our favorites. Plus, this will be a fond memory to look back on.
- Think you need something? Wait 24 hours before you purchase it then reevaluate. Consider the past purchases you’ve got stacked up in your closet that you never use. How are those working out? If you really need it, you’ll be able to drive back and get it.
- Kill the car payment by selling the car. Buy a used car with the cash you get from the sale. No financing allowed.
- Reevaluate your living situation. This is probably the toughest for people. Downgrade. Pick up a roommate (or a spouse). Move.