Last year wasn't good for me. Depression and anxiety reigned supreme. By objective standards, my life was pretty good. But subjectively, life sucked. Going into 2020, I decided I needed to make some changes. I'm pleased to report that the first five weeks of the year have gone swimmingly. Life is grand.
I've made three specific changes that I believe have contributed to this improvement:
- I've rented office space outside the house. My office is for work only. I do not allow myself to play games (or engage in other shenanigans) at the office. Zero tolerance.
- I've begun getting up early. I tend to be an early riser anyhow, but early for me means about six o'clock. This year, I'm generally rising at 4:00 or 4:30, which means I'm at the office by five.
- I've curtailed my drinking. In fact, I didn't touch a drop of alcohol during January. I've had a few drinks in February, and it's been interesting to see how it affects me, both in the moment and then for days after.
Taken together, these three changes have mitigated my mental health problems and made me more productive. I love it. Over the next six weeks, I plan to integrate two additional changes into my life: I'm going to begin exercising regularly and I'm going to cut back on videogames. I expect this to provide an additional boost to my well-being.
There's been an unexpected benefit to my quest to become a better version of me. January was -- by far -- my best month with money in years.
My January 2020 Spending
As you know, I track every penny I spend. I've been doing this since 1993 (with occasional breaks). It's a valuable practice.
Earlier this decade -- after my divorce but before my RV trip -- my monthly spending averaged about $4000. After returning from our cross-country adventure, that number spiked. From 2016 to 2018, I was spending closer to $6000 per month. This led me to push for austerity measures last year, measures that worked. My 2019 spending averaged $4221.27 per month.
In January, I spent $3212.24. This is a fist-pumpingly fine number, one that I'm proud of. But I'm even prouder of how I achieved those cuts. My top financial goal for this year is to spend less on food. I did that. And because I didn't drink, I spent nothing on alcohol.
Because I was curious, I decided to explore my spending over the past few years. I think you might find it interesting too. Here's a snapshot:
This spreadsheet shows monthly spending in select categories during the past five years. This spreadsheet does not show all of my spending. The 2016 numbers are for December only (because that's when I resumed tracking after our RV trip). The numbers for last year are only for the first half of the year. And, obviously, the numbers for this year are only for January.
- Generally speaking, my vehicle costs are low. They were high in 2017 and 2018 because my 2004 Mini Cooper needed repairs. They were high last year because I spent $1900 to buy a 1993 Toyota pickup.
- My entertainment spending is dominated by three specific expenses: my Portland Timbers season tickets, our subscription to Broadway in Portland, and my iTunes movie and TV purchases. The theater tickets are a one-time expense each February. The Timbers tickets (which I may not renew this year) are a one-time expense each August. I continue to work to keep my iTunes purchases under control.
- I spend more on our pets than I thought. A lot more. I love our dog and three cats, but wow! I paid $142 to support them last month, and there were no vet expenses in January. Much of this spending is for pet-sitting when I travel.
- Look at my food spending! Holy cats! I've been pushing hard to reduce this over the past five years, and January was a shining example of what I can get this down to if I try. Kim and I didn't feel deprived. We just made smarter choices.
- Finally, when I'm not drinking, my spending on sin -- which includes alcohol, occasional tobacco, and legal pot -- falls off a cliff. Obvious, but also wow.
I know I'll spend more in February than I did in January. Our theater tickets renew and that's a $1500 expense, for instance. Still, I expect that I'll continue this trend toward reduced spending, and I'm glad. It makes me happy. It's yet another way that 2020 is off to a better start than 2019.
"A budget is telling your money where to go instead of wondering where it went." — John C. Maxwell
I've had more one-on-one money coaching meetings during the past year than my previous twelve years writing about money combined. I used to claim that I'd never do money coaching. Apparently, I was wrong.
As I meet with folks, certain common themes stand out.
For one, most folks have no idea how much they're actually earning and spending. Their finances are like a black box. They get paid, put the money in the bank, then spend it until it's gone. Almost nobody actively tracks what they earn and spend. "Do I have money in my checking account? I can buy something!"
Because people don't track what they spend, it's tough for them to plan what they spend. Frequently, I suggest that the people I meet with make a budget. Because budgets have been demonized for so long, there's a lot of resistance to this idea. That's too bad. Budgets don't have to be a bother. When used correctly, they're an excellent way to take control of your money.
If you pick a budget that fits the way you live, it can help you meet your goals more quickly. The key? Don’t think of a budget as a constraint. Real Life is a constraint; a budget helps you break free so that you can spend on what’s important to you, on the things that bring you joy.
Why Budgets Fail
A lot of people get frustrated with budgeting because it never seems to work. They never reach their spending targets. Or emergencies break the budget. Or it seems like so much work for so little reward. I hear you. I've been there. But if you follow a few rules (or maybe "guidelines", if you prefer), budgeting can be less stressful and more useful.
Based on my own experience — and based on comments of GRS readers like you — I believe there are a handful of reasons most budgets fail. You may encounter trouble with your budget if:
- It's too complicated. People have a tendency to make budgets more complex than they need to be. A simple budget is usually more useful.
- It doesn't reflect your values. A budget should help you achieve your goals, so make it personal. If you try to use somebody else's budget, you're going to have a tough time.
- It doesn't reflect reality. When you build a budget, base it on your actual income and behavior — not on some imaginary ideal you.
- It seems like a chore. Don't let your system bog you down. Your goal is to have a budget that works, so keep looking until you find one that works for you.
To summarize: To minimize the risk of failure, a budget should be simple and easy to use while reflecting both current realities and your future goals.
That's all rather esoteric, though. What does a simple, easy budget look like? There are a lot of approaches that work. While some people do manage to make detailed budgets work, I've found that "budget frameworks" are more effective for me and the people I coach.
Today, we're going to take a deep dive into the world of budgeting. Based on my thirteen years of reading and writing about money, here are my thoughts on how to budget effectively.
"Who was there for your father when he died?" Kim asked me a few moments ago. She's interested in becoming a death doula, so she's reading a book about end-of-life care.
"It's odd you should ask that today," I said after I told her the story of my father's six-year battle with cancer.
"Why?" she asked.
"Today is the equivalent day in my life as the day when Dad died in his," I said. "It's ten days until I turn fifty. Dad died ten days before his fiftieth birthday. So, it's a somber day for me. I'll be thinking of him all day."
Actually, I've been thinking of Dad all week.
It started when I published Naomi Veak's story about how she learned to stop feeling hopeless about money. In that article, Veak shared a letter her mother sent her when she was nineteen years old. Veak was a poor kid at a rich school, and she was struggling to figure out finances. Her mother offered some words of wisdom.
I had the exact same thing happen to me at the exact same age at the exact same college. I was a poor boy at this rich school. During my sophomore year at Willamette University, when I was nineteen, my father wrote me a letter filled with financial advice.
Today seems like a good day to share it with you folks.
What happens when a half dozen money nerds spend 48 hours together in Clearwater, Florida? Do they romp on the beach? Swim in the ocean? Cook dinner together? Drink copious quantities of alcohol? Stay up until three in the morning, laughing and telling stories? Yes. Yes, they do all of these things.
But they also spend a lot of time talking about money. A lot of time talking about money. (That's what makes them money nerds!)
For the past few days, I've been hanging out with some of my favorite fellow money nerds, including Mr. Money Mustache, Paula Pant (from Afford Anything), Joel (from FI 180), Marla (featured on this Mad Fientist podcast), Ben (who wrote this MMM article about how he gets his cars for free), and the effervescent Heather, who has no blog connections at all — but might someday.
Our little group has discussed many financial-related matters this week, some serious and some silly. One particular topic has occupied a great deal of our mindspace.
Four Questions About Money
I'm not sure how it came up, but during a conversation between Ben and Paula, he asked what she'd do if she were given $100,000 with no strings attached. She said that she'd buy another rental property. (Paula is building a burgeoning real-estate empire.) Paula asked Ben how he would spend a $100,000 windfall. He didn't know.
Paula and Ben then dove deeper. They tried to attach conditions to this theoretical $100,000 to see how that altered their answers.
"When are you going to write about your hot tub?" readers have been asking. "We want photos of you in your hot tub." Fine. Here's a typical scene on any given afternoon. (This photo was taken with my iPad, and I can't figure out where the camera lens is...)
The cats like the hot tub too, but only when the lid is closed. I suspect they'll live on top of this thing during the winter.
"How much house can I afford?" Answering this question correctly is one of the keys to building a happy, wealthy life. Unfortunately, there's a vast housing industry in the U.S. that's geared toward providing the wrong answer.
You see, housing is by far the largest expense in most people's budgets. According to the U.S. government's 2016 Consumer Expenditure Survey, the average American family spends $1573.83 on housing and related expenses every month. That's more than they spend on food, clothing, healthcare, and entertainment put together!
Too many folks struggling to make ends meet focus their attention on fine-tuning their budget. They try to save big bucks by clipping coupons, growing their own food, and/or making their own clothes. While there's nothing wrong with frugal habits -- I applaud everyday thriftiness! -- all of these actions combined won't (and can't) have the same impact on your budget as keeping your housing payments affordable.
Part of the problem is what I call the Real-Estate Industrial Complex, each piece of which has a vested interest in convincing consumers that bigger, more expensive homes are better. Real-estate agents, mortgage brokers, home-shopping shows, and glossy magazines all encourage folks to buy at the top end of their budget. But buying at the top end of your housing budget is dangerous.
Buying a home is a huge decision, financially and otherwise. If you're going to purchase a place, it's important to know how much house you can truly afford.
Economists have used decades of financial stats to create computer models to predict how much people can afford to spend on housing and debt. Banks use these models to figure out how much they think you can afford to spend on housing.
Traditionally, lenders use what's called a debt-to-income ratio (or DTI ratio) -- a measure of how much of your income goes toward debt every month -- to estimate how much you can afford to pay for a home without risk of defaulting. This might sound complicated, but it's not.
To find this ratio, divide your monthly debt payments by your gross (pre-tax) income. So, for example, if you pay $400 toward debt every month and you have an income of $4000, then your DTI ratio is 10%. If you pay $800 toward debt on a $4000 income, your DTI ratio is 20%. The lower your debt-to-income ratio, the better.
Banks and mortgage brokers look at two numbers when deciding how much to loan:
- The front-end DTI ratio (sometimes called the housing expense ratio), which includes only your housing expenses: mortgage principle, interest, taxes, and insurance.
- The back-end DTI ratio (also known as the total expense ratio), which include all of the above plus other debt payments like auto loans, student loans, and credit cards.
The key thing to understand about debt-to-income ratios is that they're used to estimate the lender's risk, not yours. That is, your mortgage company uses them to check whether they think you'll be able to make the payments -- not whether you can comfortably make the payments.
If you want room in your budget for fun, you should opt for a lower debt-to-income ratio than your real-estate agent and mortgage broker say you can use.
If you're a money nerd, you can read more about debt-to-income ratios at Fannie Mae's website.
How Much House Can You Afford?
During the 1970s (before credit-card debt was common), DTI wasn't split between front-end and back-end. There was only one ratio, and it was 25%. If your mortgage, taxes, and insurance costs were less than 25% of your income, people assumed you could make the payment.
This is still an excellent rule of thumb: Spend no more than 25% of your budget on housing. (In fact, this is the number that money guru Dave Ramsey advocates.)
That said, debt-to-income guidelines have relaxed over the years.
- When my ex-wife and I bought our first home in 1993, our mortgage broker told us that our front-end DTI ratio had to be 28% or lower, meaning we couldn't pay any more than 28% of our gross income toward housing. The back-end DTI ratio was capped at 36%, which meant that our housing expenses and other debt payments combined couldn't be more than 36% of our income.
- When my ex-wife and I bought a new home in 2004, the accepted DTI ratios had grown by 5%. "That 28% figure is outdated," we were told. "Most people can go as high as 33%." The back-end ratio had been raised to 38%.
- According to the Fannie Mae website, in 2018 maximum back-end DTI ratios are up to 45% (and sometimes even 50%). These numbers are insane. Nobody should be spending half of their gross income on debt -- not even mortgage debt! That's a recipe for financial disaster.
Here's a little table I whipped up to show what sort of housing payment you'd be looking at based on your pre-tax income (the left-hand column) and various debt-to-income ratios (the header row):
A 5% increase in your debt-to-income ratio might not seem like a big deal. But when you're talking about a house payment, it's huge.
In 2016, the average American household earned $74,664 before taxes. Using this, a 5% change would be $3733.20 per year or $311.10 per month. Many folks lost their homes during the housing crisis because they took on mortgage payments that were just $300 more than they could afford each month.
I cringe when I remember learning to drive. At fifteen-years-old, I was impatient, full of nervous energy, and so short that I could barely reach the steering wheel. (Which is still kind of a problem, but I digress.)
My parents were backseat driving, of course, instructing me on how to drive the rural, dirt road just outside our neighborhood. “Let off the brake,” they said, and the car began to coast, slowly. Cool, I can handle this, I thought. “Hit the gas,” they said. Chaos ensued.
I swerved into the other lane, and when I yanked the steering wheel to straighten out, the car jerked in the other direction and I almost hit a fence post. My parents shouted. I screamed. All of us were terrified. I felt completely frazzled and out of control. It was like the car had a mind of its own.
For many of us, managing money feels something like this. We try to make a budget and set some limits for our spending, but our financial situation always seems to have a mind of its own: your bank account overdrafts, you get a pay cut at work, your vet bill is considerably higher than you expected.
But just as when you were learning to drive, developing a sense that you're in control can make a huge difference. When I finally felt like I was the one controlling the vehicle, driving became second nature.
Research, like this 2014 study, shows that simply feeling powerful inspires people to make better financial decisions. They develop financial confidence. For this reason, I’m a fan of quick money wins — small achievements that may not make a huge difference on paper, but which do wonders for how you feel about your financial situation. These quick wins won’t make you a millionaire overnight, but they can empower you, and that’s everything.
Quick wins give you financial confidence, and that helps you make better money decisions in the long run. (As the study put it, “feeling powerful increases saving.”)
In other words, change your attitude about money and you can change your behavior with it, which can lead to actually being in control of it. Try your hand at a few of my favorite money wins.
Note: Today's post is a little different. It's a letter to a young friend, who asked to remain anonymous. She's 21 and just landed her first job. Now that she's bringing home a regular income, she wanted advice on what to do with her money. Here's my response.
First up, I think it's awesome that you asked me for advice. That took guts! Plus, it's a sign that you're already making good decisions. You're being proactive, taking charge of your own life. I like that.
Like you, my parents didn't teach me how to handle money very well. They did their best, but it's tough to teach what you don't know. I've had to figure a lot of this stuff out on my own, and I've made a lot of mistakes along the way.
You'll make mistakes with money too, I'm sure. They key is to not let these mistakes compound. Don't let one mistake lead to another mistake. When something goes wrong, pause. Take a deep breath. Don't panic. Call me for advice, or ask somebody else who seems to have things figured out. Okay?
I have so much I want to share with you, but I'm going to hold back. I don't want to overwhelm you with stuff that you don't need to know right now. Do me a favor, though, and read that book I mailed you: I Will Teach You to Be Rich. There's a lot of good info in there. Some of it won't apply to you yet, but it doesn't hurt to read the whole thing so that you can know what's coming in the future.
For now, let's focus on the fundamentals.
First Things First
After thinking about this for nearly a week, I think that your focus should be setting up what I call your basic "financial infrastructure", then creating three buckets for your money.
To start, you need two bank accounts: a checking account and a savings account.
You told me that you already have a Capital One 360 checking account, which is awesome. That account has no fees. (Some banks, like Wells Fargo, charge an outrageous $10/month fee for checking. This is insane. There's never a good reason to pay a bank for the privilege of having an account with them.)
You don't need a high income to achieve Financial Independence.
Making more money helps, sure, but if you're diligent about cutting costs, it's possible to reach financial freedom on even an average salary.
I want you to meet my friend, John. John is an 81-year-old retired shop teacher. He's a millionaire -- but you'd never know it.
John started life as a carpenter. In his thirties, he went back to school to become a teacher. He spent the next twenty years teaching shop at a junior high school in a poor part of town. He retired to financial freedom at age 58. He never had a huge income and he didn't inherit a fortune.
So, how'd he get rich? He pinched his pennies and doted on his dollars. John achieved Financial Independence by ruthlessly cutting costs.
- John doesn't live in a mansion. He lives in the same small ranch house he bought for $10,500 in 1962. He paid off his mortgage early, and has now lived in the place for 53 years!
- John doesn't drive a brand-new Mercedes or BMW. He drives a 1998 Chevy minivan he bought for cheap five years ago. It's ugly, but he doesn't care. It meets his needs and he has no plans to upgrade.
- John doesn't take lavish vacations. He spends his summers in southeast Alaska on an old 38-foot fishing boat that he bought with cash in 1995. He spends his winters doing volunteer work on farms and ranches in New Zealand.
- John doesn't like to dine in fancy restaurants. He'd rather make his own meals at home. "For me, restaurants are a waste of money," he says. "I don't appreciate them."
Does John sound like a typical millionaire to you? If you were to believe TV, movies, and magazines, you might think most millionaires live like this:
We're constantly bombarded by messages that wealthy people enjoy lavish lifestyles filled with luxury. From my experience meeting with dozens of millionaires over the past decade, this kind of lifestyle is the exception not the rule.
But don't just take my word for it. Let's look at what the experts say.
Long-time readers know that I love old instructional films -- the kind of thing we older folks used to watch in high school. ("Play it backwards!")
Because the previous owners of Get Rich Slowly "unpublished" all of the old films I once shared, I get the joy of sharing them again with a new audience. Today, we start with a gem: "Your Thrift Habits", a film designed to teach teenagers how to budget.
Produced in 1948 by Coronet Instructional Films, this 10-minute short is filled with great advice -- and it's fun to watch too.