April 13, 2019
Today I want to chat to you about a seemingly simple topic – spending money.
But rather than tell you what to buy (hint: not much) and what to avoid (most things), I’ll share my own personal framework for making better financial decisions.
This stuff is like a mental checklist I run through, simply because I’ve learnt to be more thoughtful with my spending. And that’s not because I’m a monk or we’re suddenly broke. Instead, it’s down to the fact that every purchase we make has its own set of consequences – some good, some not so good.
Now of course, we could take the head-in-the-sand approach that most people take, or the hands-over-the-ears ‘la-la-la I’m not listening’ route. But where would that get us? Nowhere!
So it’s only rational that we consider what each purchase means and create a framework that helps us make better money decisions, effortlessly.
We’ll start with the most obvious. Every time we spend some cash, it lowers our bank balance, so there’s an immediate and unmistakable cost.
That’s not necessarily a bad thing. Some things are definitely worth spending money on. A trip to visit family you haven’t seen in a while. Groceries to feed your household. Phone and internet credit. Beers to share with friends. The list goes on.
But while we could justify almost any expense as worthy, we need to stop and question ourselves.
Why? Because every single day that passes, if you’re not already financially independent, then you’re giving up your freedom for that spending. So it had better be worth it!
And much of our spending isn’t one-off, it’s ongoing. It may feel like that new piece of clothing you bought was random, or your car only needs repairs every now and then.
But if we zoom out a bit, it’s very likely that we’re spending a certain amount on these seemingly random things every single year. So they aren’t random at all. In fact, they’re usually quite predictable from year to year.
So they too need to be factored into our early retirement plans. On that topic…
This point is worth repeating because it’s so important.
You probably know by now that you need around 25 times your annual spending saved up in sensible investments to be financially independent. Invested in dividend-paying shares like index funds or LICs, your savings should produce a passive income stream of around 4%
So for every $1 you spend each year, you need $25 of investments to produce $1 of income to cover it.
So that $50 take-away meal each week ($2600 per year), is not just a small way to treat yourself.
It’s a $65,000 blowout!
How long will it take you to save that extra $65,000? Still worth it?
Looking at it this way, some of your spending will likely scare the shit out of you. And that’s probably a good thing. But rather than dwell on it and think all is lost, let’s make it motivating…
For every $10 per week you can cut from your spending, that’s $13,000 less you need in investments to retire. Not only that, but you’ve now got more cash each month for investing.
As I’ve written before, start stacking up those incremental savings and watch your progress. Each time you lower your spending and increase your savings rate, plug it in this calculator to see your Financial Independence date creep ever forward.
So when I’m thinking about a purchase decision, I always think of the annual cost and multiply that by 25 to see what it’s really going to cost, in terms of how much investments we need to sustain that.
Many times that’s off-putting enough! But if I’m still considering it, I’ll move to the next layer of my decision-making framework…
Although it’s rarely said, the goal of much of our spending is to live a happy life. And that’s perfectly fine. There’s no finer goal than each of us building meaningful lives.
But there’s a disconnect. It turns out we’re really bad at predicting what makes us happy.
So when I’m thinking about spending money, I try to answer this question…
Will this make me any happier? Not just right now, but in a lasting way. And the answer is nearly always, no it probably won’t.
It’s easy to get short-term sugar-rush highs of happiness, with a holiday or a new phone purchase. But those fade quickly, leaving you back where you started, only with less cash than you had before.
In truth, the bulk of our happiness comes from the following:
So these are the key areas to focus our energy and effort on. But most of what the average Aussie spends their money on, has either little to do with these categories, or is massive overkill! This means all that cash is wasted, bringing no long term benefits.
Next time you’re about to spend money, think about this point. And consider whether that purchase is going to bring you any lasting happiness. Now I know it’s not always this cut-and-dry, but it’s at least worth pausing for a minute to think about.
This layer of consideration has really come onto my radar in the last few years.
After seeing shows like War on Waste, it’s hard not to be deeply troubled and upset by the massive consequences of our seemingly small actions.
As individuals, a plastic bottle, coffee cup or piece of clothing thrown out doesn’t feel like much. But we’ve gotta remember, there’s 25 million of us ‘individuals’ in this country alone! So our habits as individuals, can lead to a very large issue as a nation.
And saying “it’s only me”, or “it’s only this small thing” is not an acceptable answer. If that’s the case, then why not take a dump in the street? After all, it’s only you!
The problem with this attitude is, we then have millions of people thinking their actions don’t matter, when nothing could be further from the truth.
If you haven’t heard, Australia has a ridiculously embarrassing waste problem.
Further, have you spent any time in a food court recently?
Not that long ago, on a rather un-frugal day, I was caught out having lunch at a shopping centre. I noticed this particular food court had only general bins, no recycle bins. So everyone’s packaging, drink containers, plastic bags and cutlery was all getting thrown in the general waste (landfill) bin.
After sitting there for about half an hour, I lost count the amount of people dumping tray after tray of paper, packaging and leftover food into the bins. As I sat there, I realised this is only half an hour, out of one day!
Imagine the amount of waste for an entire day, an entire week, or a whole year! And this was only one shopping centre out of the thousands in the country!
Thinking about the enormity of it all, I started to feel extremely sick and saddened. So of course, when I finished my meal, I took my rubbish home with me to put in my own damn recycle bin.
This is now slowly starting to improve with more shopping centres adding recycle bins, which is a good start. But man, it’s still insane the amount of waste we generate just from picking up a bite to eat!
Anyway, back to making better financial decisions…
Nowadays, I try to think about all the resources that went into making something before buying it. Take a t-shirt for example. It takes 2700 litres of water to create, plus the resources, plus the transport and factory pollution.
Almost every manufactured item you buy will have been made in a factory spewing out smog. And almost everything is heavily wrapped in paper, cardboard or plastic, contributing to deforestation and yet more waste. And you can be sure there’s been massive amounts of transport involved – in all those materials, in getting it to the ports, in shipping it across countries, and getting it to the shop, and in us going to purchase it too.
It’s a difficult and inescapable fact of modern life. Of course, it doesn’t mean we simply opt out of modern niceties and never buy anything. But instead, it means we become conscious about what we choose to buy. Aware of all the resources that have gone into it and the environmental costs of producing it.
Ultimately, this helps us in being much more selective to determine whether that purchase is really worthwhile.
After running through the above thoughts, this is the final step. Opportunity cost is a fancy way of saying “what else could the money be used for?”
The most obvious answer of course is, investing!
Let’s say you’ve got a 15 year stretch until you reach Financial Independence. As an example, consider having $50,000 tied up in a couple of near-new vehicles, rather than $10,000 for a good used car and a bike.
This is $40,000 more than is really required. So let’s say you choose the more frugal transport option and invest the extra $40,000.
With a return of 7% per annum, over 15 years that $40,000 would grow to be worth $110,361.
So, the money foregone is not $40,000. The opportunity cost here is actually over a hundred grand!
That one chunk alone is a massive step towards a free and wealthy future.
But maybe you’re in a different situation…
Maybe you’re already retired with enough investments to comfortably sustain you. Now when you spend, you’re not forgoing any freedom, which is great. But maybe you’ve got bigger plans for your savings.
Like me, maybe you’re excited by growing your money and being able to give away tons of it over your lifetime. So let’s consider the opportunity costs now for an early retiree who receives a windfall of $100,000, whether through bonus income from their optional job, or an inheritance.
Sure, they could buy themselves a new Range Rover, or go on a number of elaborate holidays. But they’re likely to remain just as happy if they instead direct that money to a more meaningful purpose.
We’ll assume our early retiree is currently 40, and they’ll give this money away at age 90, a decade or two before the end of their big adventure on earth.
Investing this bonus $100,000 would compound to become almost $3 million!
Or $2,945,703 to be more precise. Holy shit, that’s what I’m talking about!
Imagine watching this charity pot grow and the feeling of giving so much money to good causes, rather than blowing it on a couple of short-term treats!
This is my last layer in the decision-making process. And if you’re anything like me, thinking of growing your money to buy your freedom, and then later directing it towards improving the world somehow, is way more interesting than choosing to spend more simply because you can.
All up, this four-part mental checklist helps me make much better financial decisions, and my hope is it’ll help you too.
None of it is to say that spending money is bad. Rather, that it should be done thoughtfully.
After running through this stuff in your head a few times, you’ll quickly realise that many things we spend our money on just don’t make sense, if we’re being a rational and thoughtful human. The result is, you’ll be more content with the money you do spend because it’s passed through a rigid assessment first. But there’s always exceptions, so we’ll never get it perfect.
That said, we must make a conscious effort to make better money choices, at least initially, until this self-questioning habit is formed. Otherwise, that beautiful high savings rate we’d like to have will remain forever elusive.
My spending framework reminds me what the purpose of money is. And it helps keep my decisions in line with my values and what’s important to me.
Maybe you have a different approach for making better financial decisions. If so, I’d love to hear about it. Share your tips in the comments…