Can budgeting be an effective tool for saving money and building wealth?
Does traditional budgeting work well for most people?
Most personal finance “experts” will tell you that the secret to saving money is to “create a detailed budget and track all your expenses religiously!” And then review that budget weekly and work extra hard to achieve your savings goals…
While that might work for some people, for most of us (me included!), it doesn’t. That’s because it’s too much work; you’re constantly monitoring yourself on every single expense, and having to proactively review your spending on a very regular basis.
So let’s be more efficient, and focus on the right stuff. Instead of spending all your precious time and energy on tracking and lowering all your expenses, it’s time to only concentrate on the biggest expenses. It requires a little upfront work (like most PWB strategies), but the payoffs are big.
Here’s how you build your own efficient expense cutting system:
(At this point, you’ve automated your finances, or at the very least registered for mint.com and have a good view of your spending.)
Step 1: Research
Research and find your 4 biggest discretionary expense categories. Then focus on the expenses that have highest cost per instance (CPI). That means the ones than cost the most each time you take the related action that causes the expense. Buying lunch every day is low CPI expense, while regularly buying expensive clothing is a high CPI. Let’s see an example of how this works:
Low Cost Per Instance
Coffee: Let’s say you spend $7 on Starbucks coffee visits every day. That’s roughly $210 ($7×30) per month, or ~$2,500 per year. A pretty large amount of money total, but a small cost each time you buy.
High Cost Per Instance
Expensive Dinners or Evenings on the Town: Let’s say you spend ~$100 to go out to an expensive dinner twice a month. That also comes out to around ~$2500 per year.
Which expense do you think will be easier and more efficient to save on?
Suppose you want to cut your expenses in these areas by 50%. For the coffee instance, that means 3-4 times a week (12-16 times/month) you need to completely give up expensive coffee, or every day of the week you need to spend your willpower making your own coffee or drinking that cheap stuff from the corner place or at your job. You’ll save, but it’s a lot of work and energy.
Or you could tackle the high CPI… By cutting out just one expensive dinner each month, or by choosing less expensive restaurants two times, you save the same amount of money. That’s a much more efficient use of your willpower and time, for the same savings!
Step 2: Cut The Big Expenses
After you’ve found your top 2-3 largest high CPI expenses, set a goal to cut them for this upcoming month. Be aggressive, but not unrealistic. Cutting them by 25% could be a good start. If you want to systematic about it, set recurring phone reminders for yourself to obey your new rules. Have them go off at the times when you normally take those actions. So for those expensive dinners, maybe the reminders would be Friday and Saturday early evening.
Step 3: Track Your Progress Automatically
Set up budget goals on Mint.com and track your progress (Mint will also email you when you are not on track to meet your budgets).
Step 4: Keep Cutting
Every month, try to cut your savings in these areas a little more, until you start feeling that it’s becoming very uncomfortable to cut anymore. Then maintain your levels… You probably wouldn’t want to completely eliminate going out to dinner or buying new clothes. But you’ll be surprised at how easy it is to cut down on those areas by up to 50%. And by focusing on the biggest expenses, you’ll see outsized returns on your savings and building net worth.
Here are a list of some common high cost-per-instance expenses, along with some possible ways to cut them:
|High CPI Expenses||Possible Ways to Cost Cut|
|Travel (Vacations)||Paying with rewards (Travel Hacking)|
|Dining Out||Home cooked meals, Value Restaurants|
|Clothes Shopping||1) Reduce seasonal buying (re-wear more of last years clothes!)2) Don’t “shop the sales”. You should buy things on sale, but don’t go to the store or website just because there is a sale!|
|Lavish Gifts||Instead of buying expensive items, focus on experiences (it will make you happier). And possibly work on creative or useful presents.|
|Electronics||Avoid upgrading big ticket items (TVs, Computers, Phones) until absolutely necessary.|
2 Cost Cutting Shortcuts
Travel Expenses: For many people, traveling and vacations are one of the largest (if not the largest) cost per instance expense. 1-3 times per you pay hundreds or thousands of dollars to fly and stay somewhere. Reducing that expense goes a long way to saving. I use something called Travel Hacking to eliminate most of my travel expenses. It involves strategies for leveraging credit card rewards and travel loyalty programs to pay for airfares and hotels.
Psychology Framework for Saying “No”: Even though only targeting your high CPI expenses helps you save big efficiently by only focusing on a few big saving wins, it still requires discipline and saying “No” to things you actually want to do. Luckily there are psychological tactics you can use to help yourself follow through on your goals. Here’s a great one, written by James Clear.
Building Net Worth
Always keep in mind that changes in your net worth are the bottom line of the simple equation Personal Earnings – Expenses. You build personal wealth by increasing earnings or decreasing expenses. Most personal finance advice focuses on cutting expenses, but increasing earnings is just as important, if not more important, since you can get even bigger outsized returns there. So work just as hard on boosting your earnings (career compensation + investment returns) as you do on expense cutting.