Budgeting - Putting things in perspective

June 30, 2007

 J.D. at Get Rich Slowly writes about how his friend, Gillian, can’t save any money and how he can’t help her. I understand why J.D. gave up on Gillian. It’s quite frustrating when we’re constantly making sacrifices in order to be financially healthy while people like Gillian are not willing to make the same, or any sacrifices at all, and complain they’re in trouble. They’re in financial trouble because they’re living a lifestyle they can’t afford and they just can’t see it. It’s a matter of perspective. They simply don’t see things like others do.

 While they’re thinking: “It’s OK to pay $200 for a maid because that will save me time, and I really hate doing it. It’s OK. We can afford it.”, we’re thinking “How can they think it’s OK to spend $200 monthly on a maid when they’re having a hard time building an emergency fund”.

 With people like Gillian, simply writing a list of their expenses won’t do anything. They’ll simply look at the list and say there’s nothing they can cut. That’s because they are accustomed to spending these values and it’s become part of their reality.

 So how could we change their perspective?

 An exercise I do, is to list my expenses as percentage of my income. I do this once in a while to keep my budget up to date and in context with my current financial situation (extra income, new income, loss of income, new expenses, new babies, etc). 

Gillian

Income 

 They’re bringing about $4000/mo after taxes.

Expenses 

 Using some estimated values from what I could gather from the post:

• Maid: $200/mo 
• Cell phone: $80/mo (Assuming a basic family plan with some extra services)
• Cable TV: $110/mo (Medium package with Internet Service)
• Car Loans: $750/mo (Two late model SUVs, I’m guessing around $375 each)
• Mortgage: $1500/mo (Nice custom built home - Really a wild guess here, since this depends on so many factors, like house location, size, mortgage amount, interest rates, when they bought the house, etc. I searched his blog, and found out he lives in Portland, Oregon, so assuming she lives in the same area and after some quick pricing research, I figured $1500 mortgage to be a good estimate)

 Now, trying to put it in perspective for Gillian:

 Even without listing their other expenses, like utilities, gas, groceries, insurance, student loans, etc, it’s easy to see why Gillian’s in trouble. Gillians is probably spending more than 20% of her salary just on her cars (car loans + gas + insurance + maintenance) and more than 50% (mortgage + property tax + insurance + mortgage) of her salary just to live in a nice house.

 A lot of authors/PF bloggers/financial advisors suggest us to save between 15 and 20% of our income. Using a table like this one, she can finally understand why she can’t save any money. How is she going to do that if she spends 5% of her take home salary on a maid, 20% in cars and 50% in her home? “Gillian, it’s not just $200. It’s 5% of the money you bring home.”

 Hopefully, this table will bring a new perspective to Gillian.  After studying this table, she might still not decide to change her lifestyle, but it should at least be *clear* to her that she’s living a lifestyle that she can’t afford.

My own budget

 Like I mentioned above, this is an exercise I’m occasionally doing to make sure my budget reflects my current lifestyle.

 This really helps me put my expenses in perspective. I can easily see that my home and my cars are the biggest burdens in my budget. If I stick to my budget, I’m still able to save roughly 5% of my salary. One thing to notice is that these percentages are from my take home salary - after taxes and after my 401k contribution (15%), so I’m happy with the extra 5%. I’m also planning on paying off my auto loans in a year, so that will definitely help.

 Adding the Mortgage (31.16%) and the fixed House Expenses (11.67%), my total House Expenses comes to 42.83%, which is a lot. And this is not including the Maintenance (4.68%) where I allocate a couple of hundred dollars per month for regular maintenance (insurance, repairs, small improvements, etc). 

 The other big burdens are my cars (which I do regret a bit buying them). Adding the Car Loans (15.60%) with the regular Vehicle Expenses (8.24%), it comes to 23.84%. “Oh boy, why didn’t I do these calculations before I bought the cars?”

 Now, you’re probably thinking that I’m not much different than Gillian. The difference, is that, as I always mention, everything in life is about balance, including my budget. In order to afford my home and cars, I make sacrifices in other areas. To figure out what to cut, I go through another exercise:

 I break my expenses into 3 categories:

• Essential: Things you CANNOT cut. In my case, they are my life insurance, my kid’s 529, groceries, my home expenses and essential utilities (gas and power)
• Essential for your lifestyle: Things you DON’T WANT to cut. This is a tricky category, because these are things that make us comfortable and we don’t want to cut them. But these are generally things that we can compromise.
• Lifestyle: Things I know I could cut without wanting to scream. Again, you don’t have to simply cut them. But these are generally things you are willing to make temporary or bigger sacrifices in order to keep your lifestyle.

 There are 10 categories where I could make some sacrifices in order to keep the house and car expenses while still being financially responsible. Things don’t have to be black and white. You don’t have to cut a category altogether. In my case, there are 10 categories I could try saving. If I could just trim 0.5% in each category, that would represent an extra 5% of cash at the end of the month.

 I used to eat out every day with my co workers, but I started bringing lunch from home. I also cut my entertainment budget quite a lot, cut my gym membership, downgraded my high speed internet service for a slower one and some other lifestyle changes (started dressing like a hobo). The table above represents my budget after these sacrifices. Once I’m done with my car loans, then I’ll probably adjust this table and allow myself a little bit more of entertainment and increase my work lunch budget a bit.

 In Gillian’s case, why not cut her maid to 2x a month instead of once a week? Could Gillian’s husband settle for a simpler cable package? And instead of trading both their SUVs, why not trade just one of them? Are there any extra services with their cellphones that they could cut (web access, text messaging package?).

 If she could realize that she’s living a lifestyle she can’t afford, would she be more open to cut her maid or the cable package?

 Realizing that for every dollar you bring home, 20 cents go towards your cars and 50 cents go towards your home can be really an eye opener.

Posted in Finances, Lifestyle