Stop Budgeting

September 1st , 2019

Preface

Lately I have seen a lot of videos online about millenials and how they budget their money. A recurring theme will be “I spend X on rent. Y on food. Z on transportation.” Then all the commenting will be about “Oh I think you could get the cost of rent down to X' dollars, which would save you X - X' dollars a month”. For the most part I think all this talk about budgeting is focusing on the symptoms of poor financial health instead of the causes. At the end of the day your goal to financial independence will be based solely on your rate of savings. Savings is by definition Income - Expenses, so it’s either earn more or spend less. There really isn’t anything else to the math. Sure there are helpful rules of thumb like “Save 15% of your income.”, “Spend no more than 33% of your income on housing.”, “Your car including payments, gas, insurance, and maintenance should be no more than 10 percent of your take home.”, “Your mortgage should be no more than 3 years salary.”, etc. Those rules are just guidelines that are going to differ from person to person (hence personal finance). What should be focused on are principles that lead to good financial health. It is from these principles that the rules are derived. Throughout this blog post I want to focus on some and give my opinions on the topic.

Pay Yourself First

This is an oldy but a goody from “The Richest Man in Babylon”. The idea is that you are constantly paying other people throughout your life. You need to pay the landlord for rent, the bank for car payments, the grocer for food, and various other miscellaneous that in aggregate will make the “budget”. The idea behind “Pay Yourself First” is that you should set aside a fixed amount of money that goes to savings before you even start paying for living expenses. If you can’t afford something after paying yourself first, then you can’t afford it. It’s that simple. If you are wondering how you are going to survive after paying yourself first, then ask yourself this question, “How am I alive after paying the government in taxes first?”. I think the extra irony in creating a budget (without paying yourself first) is that not only are you paying others first in money, but you are also paying them first in time and focus. You have to spend all this time coming up with an elaborate budget that really is hard to stick to. In terms of paying yourself first, I think you should thrive to max out all forms of free money and taxed advantaged accounts first. Trust me there are plenty of them that you need to take advantage of. Here are just some that I have in mind:

Maxing out these accounts is going to take about $55,900 and contribute $65,400 towards your retirement. After 40 years at 7% you will have $13,970,065.87 of mostly non taxable money. If you aren’t maxing out these accounts, then you are leaving money on the table (or for Uncle Sam on April 15th). With this in mind, figuring out how you are going to paying yourself first should happen before you even consider a budget.

So before you even draw out a budget you should figure out “How much money do I need to retire?”, which should in turn tell you “How much you need to invest every month to make it happen”. Shameless plug: you can read my post about planning for retirement to find out how much you need to retire. For example, if you need $1,000,000 in today’s dollars to retire in 40 years, then you need $2,208,039.66 in 40 years to retire due to inflation, which works out to investing $900 a month, every month, for 40 years, and at 7% interest. After our example person can figure out how to invest $900 a month (probably after increasing their income), then they can worry about budgets.

Budgets Aren’t Rational

Suppose you are walking around and you stumble upon a thingy-ma-bob that is selling for $5. After some self reflection you come to the conclusion that the thingy-ma-bob is worth $10 to you (after all opportunity costs are accounted for). Now you go on your Mint.com app to see if the thingy-ma-bob fits in your monthly budget for thingy-ma-bobs. You find out that you are $2 dollars short and decide to walk away knowing that you are now “within budget”. Assuming you actually had the cash for the thingy-ma-bob, you just made a very irrational decision of walking away from a transaction that would have netted you $5 worth of utility. This is one of the many flaws of budgets. On top of that you had to pull out an app before every transaction to see if it’s “within budget”, which is costing you a lot of time and mental energy.

At the end of the day the only purpose money has in life is to be spent. If that money isn’t being spent to increase your utility and help you achieve your life goals, then it has no real purpose. I think a simple rule of thumb is to “spend on what you value”. If you value something more than the price that is being charged and you have the cash, then who can really tell you not to buy it?

You Can Only Cut Out So Much

One stereotype for why millenials are poor is because they spend $5 every day on coffee and get avocado toast for brunch. A lot of people will point to the coffee and say “That needs to leave your budget. It’s going to make you poor. $5 every day for 40 years at 7% is $389,837.46.”. Sure $389,837.46 sounds like a lot, but it’s really nothing compared to the $13,970,065.87 I mentioned by maxing out tax advantaged accounts. The $5 coffee is kind of just an example of how you can only cut out so many things from your budget. Another example is rent. You need to live near your work or else you will suffer from a long commute, which I think might be worse for your health than being financially illiterate. It might also be a penny wise but dollar stupid move to live further away from the office to save money.

Here is the back of the envelope math:

The average US household makes $56,352‬ a year post tax (Source) and there are 2,080 hours of work in a year. This translates to about $27.09 an hour. The average american also commutes on average 200 hours a year to work (Source) equating to $5,418 in time wasted in a commute. To put that into perspective the average household spends $10,080 a year on housing (Source). In other words, if you are the average household trying to save money by living living further away from work, then you are wasting 53% of your housing budget to “save money” on your housing. This hasn’t even factored in the car, gas, insurance needed to drive to work. We can do the math again if you want to argue for public transport.

You can repeat these experiments again for other living expenses and find that there really isn’t much you can cut out without costing you more valuable resources like time. What you should hopefully find out is your “lifestyle expense”. Your lifestyle expense is your expenses minus your bare minimal cost of living. My definition of “minimal cost of living” is whatever is required for you to pursue more valuable things in life. For someone like Bill Gates having people on payroll to help him is part of his “minimal cost of living”, since if he didn’t he would be spending even more in his time doing things like washing dishes (ironically he actually washes dishes for fun). Everything outside of these expenses are “lifestyle expenses”. For example Bill Gates owns a nice Porsche that he likes driving around. Gates could probably forgo on the Porsche and his ability to pursue other goals in life would be unhindered. These lifestyle expenses are basically the maximum you could ever hope to cut out by having a spartan budget. I think for most what you will find out is that the money you save by cutting out lifestyle expenses is not going to make a meaningful difference in your life.

Stop With the Scarcity Mentality

Ultimately my biggest problem with budgets is that they create a “scarcity mentality”. It makes people focus too much on not spending as if they will never see another dollar enter their bank accounts again. The reality is as long as you have time and health you can always trade it for money. So what I think people should focus on is “How can I use my time and health to earn more money?”. If your income isn’t enough to help you achieve your life goals and save for retirement along with the lifestyle you want to live, then the income is the problem (not the budget). You need to increase your income either through promotions at work, creating more streams of income, or reinvesting back in yourself (your greatest asset).

Clarifications

So there are some clarifications I want to make. When I say “Stop budgeting.” I don’t mean you should “waste your money on frivolous things you don’t value.”. If there is something that is costing you a lot of money and it doesn’t add value to your life (or “spark joy” as Marie Kondo would say), then just cut that out. You also shouldn’t mindlessly spend money. In fact, I think you should know down to the cent where your money is going. Apps like Mint.com make it all too easy these days to review where your money is going. On a somewhat regular basis you should just review where your money is going and see if it was worthwhile. If not you know where you aren’t going to spend your money next time. Continue this process enough and you should iteratively converge on an “optimal budget”. I also think making mistakes are important to your financial (and mental health). If you never make a mistake in a purchase, then you will never know what you value and don’t value. If you also never purchasing anything out of crippling fear of a budget, then you are going to live an unfulfilling life. Now if you happen to be the type that enjoys watching your money grow rather than spending it on desires that’s optimal. Ultimately, this is an opinion piece and only you can decide how you should live your life (and not some random person on the internet).

Discussion

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Email: bschong2@illinois.edu

bchong95

bchong95