In general, the frugal person who saves and invests will slowly build wealth, and will find herself far ahead of her peers. But sometimes the progress is slow — or even non-existent. When this happens, good financial habits can seem frustrating. Sara wrote to ask what to do when frugality seems to be getting you nowhere:

Although I practice extreme frugality, I feel that I cannot get ahead financially. Every month I seem to be back in exactly the same place as I started the month before. Here are the details:

  • I am 24 years old and have never carried credit-card debt.
  • I have $4000 in student loans at 2.5%.
  • I am responsible for half of a mortgage at 5.5%.
  • I work 20-25 hours of overtime every week for extra money to save.
  • I contribute the full employer match to my 401(k).
  • We eat all our meals at home and pack our lunches everyday. I cook lots of beans and rice and other low cost foods.
  • I do not drive a fancy new car or buy fancy new clothes. In fact, I do not buy many consumer goods at all.
  • Every month, I pay extra principal on the mortgage and put extra money toward my student loan.
  • Every month I put money into an ING savings account.
  • Every month I put money into an index-fund Roth IRA.

Even paying extra on my student loans, it will still take years to pay them off. Even though I am putting 15-20% of my gross income into a 401(k) and an IRA, the balances don’t go up. They go down, or, if I’m lucky, they stay the same. Even though I put money in savings, I seem to have no progress because the savings rate is so low. Even though I scrupulously keep track of my tax deductions, my tax refund from 2008 will be less than $20. When I think of what I pay in taxes, it makes me feel queasy.
Why does it seem that I am doing all the right things but getting all the wrong results? I feel like I have been running in circles, going no where fast, and I am exhausted.

Saving money is work. It’s a challenge. Success does not come overnight. And, in fact, there can be long stretches where it seems nothing is going right. This is especially true if the economy at large is conspiring against you. You may be making good choices, but if interest rates are low and the stock market is declining, it will seem like you’re making no progress (or maybe even losing ground).

I believe that Sara is doing the right thing. Obviously there’s no guarantee that she will be successful, but it’s my belief that if she continues to make smart choices, she will be rewarded in the long run.

My advice — and it feels odd to say this — is for Sara to be a little less thrifty in the present. I think she should reduce the extra payments on her student loans (and possibly her mortgage), at least for a little while. She should use this money to pursue something that she enjoys or that gives her life meaning. She might, for example, save for a trip to Europe, or for a new bicycle.

Since re-discovering it last autumn, I’ve become an adherent of Elizabeth Warren’s balanced money formula, which is designed to let people build wealth while also setting aside some money for fun. Warren says that, ideally, no more than 50% of your paycheck should be spent on Needs. Of the remaining amount, at least 20% should be devoted to Saving, while up to 30% can be spent on Wants.

Here’s what the balanced money formula looks like:

This simple plan has made a huge difference in my own life. Because I’ve reduced my Needs to below 50% of my net income, I’m still able to meet my Savings goals and have plenty left over for Wants. But the key is to allow myself to actually spend on Wants. For a time, I wasn’t doing this, and it made money management a drag.

My guess is that by allowing herself a bigger budget for Wants, Sara will feel better about her progress. But I also think that she needs to be patient. She’s only 24. She’s young, and she’s making smart choices. I believe that in the long term, she will succeed. But it takes time. Right now she’s being thwarted by one of the worst economies in the past 100 years. That’s a powerful tide to swim against!

What do you think? Am I completely off base? What advice do you have for Sara? Should she stay the course and continue to embrace extreme frugality and debt reduction? Or should she lighten up in an attempt to find some balance? Are there other options that I’m forgetting? How can she begin to feel like she’s making some progress?

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