This guest post is from Mr. F, an Australian reader in his mid-20s who works for the government.
We're often told to “spend money on what's important,” “spend according to your values” or “spend on whatever takes up most of your time.” So, for example, you should spend money when it comes to things like education, or family, or on a mattress.
That's a good guide, but in day-to-day situations you often have to make a number of smaller decisions about when and where to spend money, and it's not entirely clear how you should be applying these guidelines. Even when you set aside money for specific categories, there's always an implicit choice to be made – should I spend the money now, or should I wait until later in the week/month/year to exhaust this budget item?
For example, let's say you're an avid computer gamer, and you see a game or two on sale. You weren't really looking to buy the games now, but it would be nice to have them, and you would definitely play them and get hours of entertainment out of them. What should you do? In a lot of situations, you could justify either decision. If gaming is important to you and you would use the games, then a strong case can be made for making the purchase, especially if they're only on sale for a short while. On the other hand, it's not a strict need (nor even a strict want!), and you may want to spend the money you have set aside for entertainment on other things. Importantly, you want to make sure the decision you make is being made for the right reasons and not just because you kind of happen to be in the mood to splash out, or not.
In other words, you need some sort of objective standard.
Creating objective rules
Anyone who's done performance reviews or project management will no doubt have come across “S.M.A.R.T. goals” (specific, measurable, attainable, relevant, timely). The point is to create clear goals for individuals that can be assessed in an objective fashion. So instead of the goal being “get better at sales,” the goal is “improve sales numbers by 10 percent in the next financial year.”
A similar philosophy can be used in developing personal finance rules:
Specific/Measurable These two are closely related. You want to create rules that have clear criteria that can be objectively measured. This usually means having a numerical basis for the rules. For example, you can only get take-out once a week. A good way to know if you have an objectively measurable rule is to ask yourself if someone else could look at your spending, and easily work out whether it complied with the rule or not.
Attainable There are really two concepts bundled up in this word. The first is that the rules you set have to be rules that you will be able to follow. There's no point setting incredibly harsh rules for yourself that you'll either be unable to follow or will follow but will be miserable doing so.
The second concept, which is related to the first, is that to some extent there has to be some flexibility. The reality is that we are all human. We have finite willpower, we have changing desires and some days we just don't feel up to the task of being frugal.
Now, I understand that this may seem like it conflicts with the idea of making specific/measurable rules, but ultimately it's about striking a balance. For example, you might restrict yourself to buying clothes only when they cost less than $50, but perhaps once a month you are allowed to splash out on an item above this mark. These little indulgences are important and in fact go a long way to helping you stick to your rules.
Relevant This is really about explaining why you make the rule. You want the rule to be a manifestation of your overall personal finance philosophy. As you formulate your rule, you should think about whether it aligns with your broader finance goals.
Timely This is perhaps the least applicable, but I still think it has some relevance. I think a good rule is one that is time-based, partly because it adds discipline but also because it makes it easier for you to “reset” if things go wrong.
I've found these kinds of rules give me a good basis for measuring my decisions, and not getting caught in a situation where I try to retrospectively justify my actions. It also helps me avoid feeling guilty about spending money, or indeed, feeling overly cheap when I elect not to spend money.
I've already decided what's important to me, and I've determined an objective standard for what constitutes sensible spending in advance. This means I can spend (or not) confident in the knowledge that I'm not being profligate (or cheap), and that I won't regret it later.
Some of my rules in practice
I use this to simplify a lot of decisions I make. For example, I usually take lunch from home; sometimes I make things specifically for lunch, other times I'll take leftovers. However I do enjoy eating different things, and lunches are a good way to meet up with friends who also work, so I allow myself one or occasionally two days per week where I'll buy lunch. I've actually ended up creating a set of rules that guide my decision-making over lunch:
- If I buy lunch twice, at least one of them has to be a cheaper option (wherever possible).
- If I have bought lunch already in the week (or am planning to buy lunch later), I have to take leftovers whenever they are available.
- If it gets to Friday and I haven't bought lunch, and there are leftovers on Thursday night, I can elect to buy lunch on Friday if I want.
These allow me to spend according to my overarching principles, but they also give me flexibility to adapt to the uncertainties of life. Perhaps most importantly, they're not so draconian that I can't follow them: I've got the option if I'm busy or having a tough week to buy lunch more often, but if things are going well and I'm up for it, then sometimes I will go the whole week without buying lunch.
Another tough one I've found is going out in the evenings to meet friends. I think we can all agree that seeing our friends and family is an important priority and worthy of spending money on, but it can get out of control. Of course you can suggest a DVD night instead of going to the movies, or a potluck instead of going out to a restaurant, but if everyone's working and has a busy life, sometimes it's just not viable. So, inevitably you'll end up in the city, meeting people for dinner, drinks, movies, shows, etc.
The rule I apply is that if multiple events are planned, and one of them includes a meal (say, catching dinner and then going for drinks), I try to substitute the meal by eating at home instead. For example, the other night I was going to a friend's house to play cards, and since a number of us worked in the city, they made plans to get dinner and maybe a beer after work, and then drive out to my friend's place. This represented an easy decision: While I wanted to see the guys and catch up, I knew I would be doing that anyway later than night. If I went out beforehand I'd easily end up spending $30-$40 on dinner and drinks.
Returning, then, to the computer game example, I've found that, on a dollars-per-hour basis, computer games are one of the cheapest ways to entertain yourself (for comparison, just think about how many hours of entertainment you get from a $20 movie ticket). As a result, I allow myself to buy games that are well-reviewed or look like they'll be of interest to me, if I see them on sale. Alternatively, if I hear/read about a game, or there is a new game coming out that I want, I can only buy it if I can find it on sale, or if I can find it cheaper than what I can get it for on Steam (eBay is usually a good source of games, especially second-hand games). This means I only buy games when they are cheap, and I force myself to look for cheaper options to buy newer games.
Making your own rules
In my mind, things like “spend money on what's important” or “spend according to your values” represent the Why, whereas the concrete rules above represent the How. If you really want to put your spending philosophy into practice, you need to sit down and think about some concrete rules. It makes life a lot easier in the long run. What are some of your rules?